Analysts Dig for Clues Amid Options Inquiries [WSJ]
Maze of Reports Swamp Investors Trying to Divine Firms at Risk;
A Green Lining in Dark Cloud?
By GREGORY ZUCKERMAN
May 25, 2006; Page C1
As investigations into stock-option practices heat up, investors are being inundated with a flood of reports from analysts looking for companies that may come under the microscope.
The methodologies behind the studies vary, making it difficult to independently verify the conclusions. Still, shares of some companies are suffering even though there isn't any indication that they acted inappropriately. Others are tumbling, though the abuses might not affect their businesses. So some investors, rather than shying away, are trying to figure out if the scrutiny is creating some bargains.
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So far, about two dozen companies have disclosed that they face federal investigations or inquiries from their own boards over options timing. Securities and Exchange Commission Chairman Christopher Cox said Tuesday that possible backdating of stock options is "a matter of ongoing interest to our enforcement division." Federal authorities are investigating whether a number of companies backdated their options to certain days when the stock prices were at a low to allow executives to reap gains ahead of subsequent increases in the prices of the shares.
The SEC has been examining the matter for more than a year. In a page-one article in March, The Wall Street Journal did its own analysis -- using statistical methodology reviewed by university professors -- and identified a half dozen companies with suspicious grant practices. The chief executives of those companies routinely received grants dated ahead of sharp rises in share prices.
Just yesterday, CNET Networks Inc. said it had been notified that the SEC is conducting an informal inquiry into the company's stock-option grants. The San Francisco company said it plans to cooperate. In addition, Analog Devices Inc. said it received a subpoena from federal prosecutors over stock-options grants. The Norwood, Mass., company said it would cooperate. And Power Integrations Inc. said it is cooperating with the SEC and the U.S. attorney's office for the Northern District of California in their investigations of the San Jose, Calif., company's stock-option practices.
Stock options usually give employees the right to buy shares later at the price of the stock on the date of the grant. If shares rise from the grant price, the employee profits by exercising the option and selling the shares. Granting an option at below-market value without disclosing the discount could violate securities laws. It also can lead to accounting and tax problems, all of which can weigh on shares.
Marvell Technology Group Ltd., Linear Technology Corp. and Maxim Integrated Products Inc. were named in a report this week by Merrill Lynch analyst Joe Osha about semiconductor companies that generated "excess" returns following option grants from 1997 to 2002. Marvell executives who received options, for example, saw their shares rise an average of 36% during the 20 days following the granting of options during those six years, compared with an average annual decline of 14% for Marvell shares in those six years.
A spokeswoman for Marvell declined to comment. Representatives of Linear and Maxim didn't respond to requests for comment.
Some investors said they are reviewing companies in their portfolios, looking to sell shares of those that were heavy issuers of options and that they judge to have poor internal controls or weak corporate governance. Their worry: Large institutional investors, such as pension plans, may dump shares if improprieties emerge, in part because they could suggest other potential problems at the companies. Another risk: executives potentially leaving as part of any probe.
Some of the studies being conducted by analysts and others cover relatively short periods of time, raising questions about their usefulness. Some investors said the recent weakness could turn into a buying opportunity for some shares. Some believe that, unlike revenue-recognition issues and other improprieties that weighed on stocks in the past few years, backdating options likely wouldn't suggest that the health of a company is worse than it seemed.
Alan Fournier, who runs Pennant Capital Management LLC, of Chatham, N.J., with $1 billion under management, profited by buying shares of Mercury Interactive Corp. last fall after the company acknowledged "misdating" options and a number of senior executives left. He is among those looking for potential bargains.
"The risk is that these companies buried other things" in addition to committing possible option-related improprieties, he said. "But as long as the cash flow looks solid and a careful examination of the cash-flow statement or balance sheet is undertaken, you can get comfortable that it isn't related to the business."
Some are bailing out of stocks caught up in the investigation -- even when there isn't any indication of wrongdoing and even as the businesses are gaining ground. Shares of Quest Software Inc., for example, which has a $1.32 billion market value, tumbled 16% after analysts last week suggested the company might have backdated some options.
According to Sarah Friar, a Goldman Sachs analyst, around the dates of the option grants during the 1998-2002 period, 33% of Quest's options were priced at the lows for the 40-day trading period, a high figure compared with others in the business. Ms. Friar cut her recommendation of the database-managing software company to "neutral" from "buy" last week, worried that the option issue will weigh on the stock.
On Monday, Quest said that its board formed a special committee to investigate. A spokesman declined to comment.
Quest doled out only six option grants in the four-year period, with two at the 40-day lows, potentially reducing the significance of any possible impropriety. With shares down sharply, the fear could be baked into the stock. Quest's revenue is growing at a 20% annual clip, Ms. Friar noted, suggesting that, if the company emerges from the investigation unscathed, the stock could climb.
Some of the companies being named as possible backdaters have denied it. The Merrill report, for instance, also names Novellus Systems Inc.; the stock has fallen almost 6% in the past week. Novellus said Monday that it had reviewed its option grants and found "no irregularities," according to a statement.
A Goldman Sachs analyst named Computer Sciences Corp. as a company that might come under scrutiny for its options. But late Tuesday, Computer Sciences said the company's grants of stock options have been "appropriately authorized in compliance with all applicable rules and regulations," and the Goldman analyst, Julio Quinteros Jr., later said the performance of the stock options "appears coincidental."
Yesterday, Cowen & Co. analyst Jim Friedland said his work suggests that Amazon.com Inc., eBay Inc., IAC/InterActiveCorp and Yahoo Inc. are among those in which there isn't any "recurring evidence of suspicious awards," though he noted the analysis was rough considering the stocks' volatility during the period. |
