Dellionaires are employees who have become rich on Dell stock options.
Better Living Through Equity
By Scott Burns
Why employee stock options have become Corporate America's most sought-after perk
Think of it as Superperk. It is beyond mere money. The folding stuff of pay envelopes and checking accounts. It is beyond Supermoney, the phrase Adam Smith used to describe common stock during the go-go years of the 1960s. Options are Supermoney on steroids, and the broad distribution of stock options to employees marks the biggest change in employer-employee relations in the 1990s, affecting not just what people are worth but how and why they work.
The pace and scope of options awards seems to be accelerating. A recent study by the National Center for Employee Ownership estimates that employees control about 8.3 percent of total U.S. corporate equity, worth about $663 billion, up from 1 or 2 percent only a decade ago. Employee stock-option plans account for about $200 billion of that total. "In 1992, there were only one million workers covered by stock- option plans," says NCEO director Corey Rosen. "We estimated the Þgure at six million last year, and it's growing very quickly. It's probably seven million or more now. That's a 600 percent increase." Employee demand for a piece of the action helps explain this phenomenal growth rate. Listen to George, who moved from a major newspaper company to an electronic publication a few years ago. "If I had stayed where I was," he says, "I would have a secure job with small pay raises and an occasional shot at a small bonus if we had a good year and if the muckety-mucks at the top didn't scarf it all up. Here, I can make my entire salary in options profit if we have a good year." Computer whiz Devon Lazarus, a 31-year-old in charge of technical stuff at Digital Think, a San Francisco start-up that creates and markets interactive study courses on the Web, puts the case for options even more succinctly. "Options are my chance at the lottery," he says, "except that I have some control over whether I win."
The appeal to employers is just as strong, especially in the various centers of the cyber-economy, such as Silicon Valley and Redmond, Washington. In these precincts, product cycles last less than three years, and the idea of a long-term investment plan -- one that stretches out for 20 or 30 years -- seems as far-fetched as spending that many years working for the same company. Without options, management at tech companies would have no reliable means of rewarding and retaining their human capital.
But employee retention is only one reason companies like options. "Part of why options programs are proliferating," Rosen explains, "is that wages have been growing very slowly. Companies, pressed on costs, are saying, ‘If we can't pay more in wages, let's pay more in equity.' In a financial sense, they are moving compensation from the income statement to the balance sheet." That shift isn't popular with everyone. Much has been written recently about the billions of dollars that companies such as Microsoft and IBM pay to buy in their own stock that they then issue to employees who exercise their options -- that is, convert their options into actual shares. But Rosen contends the cost for most companies is reasonable. "In a typical case," he says, "the impact on earnings is a hit of 5 to 10 percent, and that includes executive stock options. With executives getting 55 percent of the options, the employee impact is something like 2 to 5 percent. It only becomes a large number when the company is wildly successful," and it costs hundreds of millions or even billions of dollars to buy in enough stock to cover the options that employees exercise.
That's a cost some companies are willing to bear. Dell Computer is one. The options-award program at Dell (Nasdaq: DELL; recent price, $63.25), one of the standout technology stocks of the 1990s and a pioneer in the "mass customization" of computer hardware, has created a new class of citizen in Austin, Texas, where the company is headquartered. The legions of employees who have become rich on Dell options are called Dellionaires. They build big houses, buy luxury cars for cash, and live well. Most of these thousands of employees earn salaries that are no better than average, yet their net worth has skyrocketed along with the price of Dell stock, which has risen more than 8,400 percent in the past five years.
It's possible to roughly estimate how much wealth stock options have created for Dell employees by analyzing the company's 1998 annual report (Dell's Þscal 1998 ended February 1). As of that date, Dell executives and employees held options on 110 million shares. Some 28 million of those options were exercisable -- that is, convertible into Dell stock - - at a weighted average price of $1.16 a share, and that was before the stock split two for one. The split reduced the average exercise price to 58 cents a share. In essence, the lucky holders of these options were able to buy Dell stock at 58 cents a share at a time when the stock's price on the open market was closer to $63. That translates to an aggregate profit of about $3.5 billion -- and that's on just one slug of options. Altogether, Dell employees have options on some 220 million post-split shares, which represent about 15 percent of the company and some $14 billion in wealth. That's an average of $870,000 for each of Dell's 16,000 employees. And even assuming that top management gets just over 50 percent of the options wealth -- the average for corporate America -- that still leaves about $435,000 each for the other employees. And you're worrying about whether your raise will be 3 percent or 5 percent?
Naturally, employees in the rest of corporate America would like a shot at the outlandish wealth options promise. "That's all anybody wants around here," exclaims Felicia Moore Lindau, a former marketing whiz in the San Francisco office of Foote, Cone, and Belding. While at Foote Cone, Lindau was so turned on by the work she did for a client -- bookseller and Internet-stock-of-the-moment Amazon.com -- that she decided to get in on the start-up game, too. She left Foote Cone and, with business partner Jason Monberg, raised some venture capital and set to work creating Sparks.com, a Web site that will sell greeting cards over the Internet.
Sparks.com is Lindau's ticket to the start-up options that could make her hugely wealthy if she can take the company public in the next few years. Though risky, start-up options are the filet mignon of options, because their exercise price is set so low. The next-best options are any awarded before a company goes public. Once a company goes public, quick profits are far less likely, although patient holders are usually rewarded with long-term gains.
Computer whiz Devon Lazarus of Digital Think is another Bay Area denizen who's waiting, not so patiently, for his employer to go public so that he can convert paper profits into real wealth. Tall, pale, with a shaved head and dressed in a black-and-white shirt, black pants, and a silver earring, Lazarus looks more like a punk rocker than the intensely focused capitalist he is. Raised in a series of foster homes, he has worked since he was 14 and has a gift for taxonomy -- for making clear distinctions and quickly sorting the world into categories. It's the kind of mind that can easily negotiate the complex structures of large databases and computer file systems.
It's also the sort of mind that long ago grasped that options, not salary, were his best shot at the self-sufficiency he has craved since he was a child whose life was governed by the whims of the foster-care system. His early career was hardly promising. "I had to drop out of college after the first year," he says. "No money. But I had started to dabble in computers." His burgeoning skill led to a series of relatively low-level jobs running computer networks. Then he landed a job as a production manager at online publisher CNET. "In that move I cut my salary in half," he acknowledges. But there was method to his madness. "CNET was very close to going public, and they gave me 5,000 shares at a strike price of $19," he says. "That was my first exposure to options."
But he soon wearied of the "disorganization and incredible expectations" of CNET. He left the company and took six weeks off to think about his next move. "I wanted to invest myself in a company I could have a hand in molding," he says. That company turned out to be Digital Think, which has raised $1.2 million in seed money on the strength of its plan to train the world over the Web. Once again, Lazarus signed on for a below- market salary. "But I have about 1 percent of the company, perhaps a bit more," he says. The options have given Lazarus a sense of ownership, of involvement in Digital Think's fate, that he never could have derived from a mere salary. "Over the last few years I've had a good chance to influence the company, its success and its product," he says. "I've had a role in defining the culture of the company."
For a price. "I think I'm making about 75 percent of what I might make elsewhere," he admits. "I have forgone salary increases to increase my options. But if things go well, my shares could be worth, maybe, a few million."
That prospect tends to color a young man's sense of the future. "Options have actually changed my way of thinking about life," Lazarus says. "I seem to get a feeling of security from them. I seem to feel that I can take more chances. Last year I spent $12,000 racing my motorcycle. I can do that because of the options."
The security he's talking about has little to do with the sort of patient, grow-rich-slowly approach that personal-finance experts recommend. "I still invest in my 401(k)," he says almost sheepishly, as if confessing to a vestigial belief in Santa Claus, "but I'm not counting on it for anything. It's gravy." That may sound heretical, but Lazarus has done the math: Even a 401(k) plan with a generous match pales against the potential winnings that options on a hot start-up represent. For instance, after five years of contributions at the maximum level with a 50 percent employer match, a 401(k) plan would be worth $103,882, assuming a 10 percent annual return. It would take nearly 13 years to accumulate the $437,500 Dell employees have averaged in five years.
Not every company that issues options is the next Dell, though. As Lazarus notes, options are a lottery, and lotteries have losers. Falling into that category are the employees of Ciena, the outfit founded in 1992 to exploit a process for multiplexing light signals beamed over Þber- optic cable. The technology was expected to multiply the amount of data þowing through the cable, opening the fast lane of the information superhighway.
Going public at $23 a share in February 1997, Ciena (Nasdaq: CIEN, $16.69) reached a high of $92.38 last summer after it agreed to merge with Tellabs, another company in the business of speeding up data communications. With options on 9.1 million shares of company stock, at a weighted average exercise price of only $7.33 a share, Ciena employees were looking at nearly $800 million in options profit as recently as last July.
Then the deal with Tellabs fell apart. Ciena shares plummeted to $8.13, a 91 percent loss from their high, before recovering to their present level. At the low, virtually every dime of that $800 million in option value had been destroyed. Faced with losing a major employee incentive - - not to mention the employees themselves -- Ciena directors voted to put employees back in the money by repricing any options with a strike price over $12.375 to $12.375.
Far less cataclysmic events can still have a profound impact on options values. Take Pixar (Nasdaq: PIXR, $46), Apple founder and CEO Steve Jobs's animation studio. Last spring, hordes of Pixar employees, hoping to make a cash mountain out of an animated anthill, worked night and day to meet deadlines for the film A Bug's Life. But then came the collapse of the Asian and Russian economies. Equally important, at least at Pixar, was the preemptive release of Antz by the competing DreamWorks Pictures. Investors, reasoning that one cartoon-bug film was enough for most moviegoers and that Antz was likely to be that one film, knocked Pixar shares down from a July high of $66 a share to a recent $46. That reduced employees' potential profits on their 8.4 million options by $170 million.
In the end, most workers with options probably won't be as lucky as the Dellionaires or as unlucky as the Ciena employees. At the National Center for Employee Ownership, Corey Rosen and his research director, Ryan Weeden, have performed studies that suggest options are a good deal but not nearly as lucrative as the popular imagination would have them. "If you value the grant at the number of shares times the exercise price," says Rosen, "we found that the average professional or technical employee received $37,000 to $41,000, while the average administrative employee received $12,500. Another way to look at it is that an average option grant is about half a year of pay."
At that level, options are more like fourth prize in the lottery than the whole jackpot. "Most people won't accumulate a great deal of wealth," Rosen says. "It could be wealth if it was invested. But the money from options is usually spent on making life better." In other words, options may not enable their holders to move to a better neighborhood. But maybe they can commute to the same old one in a nicer car.
Contributing editor Scott Burns is the personal-finance columnist for the Dallas Morning News. His E-mail address is scott@scottburns.com, and his Web-site address is www.scottburns.com.
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