Pirah,
I would like to thank you for trying to keep us focused in our discussion of employee stock options. While speculating about management motivations for stock buybacks, debating the proper amount of grants, etc. are stimulating discussions we risk not dealing effectively with the core issue for shareholders. Substantial employee stock option grants appear to be a given for Wind River. As you keep reminding us, we need to develop an understanding of how and to what extent these options are going to impact our investments. Even if all employees are deserving of every option granted and even if it is absolutely necessary to give options in order to hire and retain employees so that the company can grow and even if these incentives lead to an extended period of high growth if in the end the resulting dilution is too great shareholders may end up with little gain or even outright losses.
Just so that there is no misunderstanding I have no interest in bashing WIND. I have been a shareholder since shortly after the 1993 IPO and have benefited greatly. During this time I have been very impressed with the company's management and their execution and I expect that the company will grow at a high rate for a number of years into the future. However, I am concerned whether this will translate into increased shareholder value. We shareholders have our capital at risk and should not settle for anything less than a hard nosed analysis of the potential dilution effects of these options. If this leads to an understanding that this is of little significance, great. I would love to hold on to my shares for many more years. But, if the conclusion is that this will have a big impact we certainly want to recognize this now not after the damage has been done.
Today the issue of employee stock options and resulting dilution is barely in the consciousness of most investors. It is just beginning to show up in critical articles in the press. The visibility of this issue seems certain to escalate over the next year or so and will make the quality of reported earnings a hot topic. In many ways this reminds me of the scenario that occurred between the mid 60's and mid 70's. Then the driver was inflation. As inflation began to pick up in the late 60's it exerted a beneficial influence on reported earnings just as unrecognized compensation expense does today. Initially there was not a lot of attention paid to these inventory profits and thus the higher reported earnings were supportive of higher stock prices. This did not last. The recognition and criticism of the phoniness of reported earnings increased so that by the early 70's earnings reports were intensely scrutinized and discounted. Earnings were no longer taken at face value. The quality of the earnings is what counted. From the mid 60's to the mid 70's corporate earnings grew greatly but the P/E multiples assigned to those earnings went from the high teens down to single digits. Quality of earnings seems to once again be destined to become a high profile issue with employee stock options being one of the drivers. It would behoove us to understand this issue as it pertains to WIND, whether good or bad, before the market renders its judgment.
Pirah, you have made the point that shareholder dilution is the major concern. I concur with this. Allen has stated "The problem is the investor has only passing interest in the value of stock options at the time they are granted. In the final analysis, the investor is very interested in how much his/her stock is being diluted." We seem to have a consensus here. I would think that we could pursue this by creating models based on a range of reasonable assumptions and calculate estimates for the future dilution impact from the on-going employee stock option grants. For example, Allen has made projections for the future growth of WIND's earnings. We might select a high and a low P/E to create two different future stock price scenarios from these earnings. We could assume that the historical pattern of option grants will continue. We could consider exercise when vested and again at end of life. I am not trying to be definitive here just trying to point out that we should be able to make some ball park estimates that answer the question of whether or not this is a serious problem for shareholders.
Unfortunately, I have to leave on a trip today and will not be near a computer for the next week. When I return I would like to pursue this further. Meanwhile, the thoughts of you and others on this approach would be appreciated.
Regards, Michael
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