endgame
Thousands of Employees Endure Wait To Turn Their Paper Wealth Into Cash
By DAVID BANK
Staff Reporter of THE WALL STREET JOURNAL
Frank and Nicole Ward's dreams ran a tight race with the falling stock
market. Late last month, the dreams won by a nose.
The Wards both work at Covad Communications Co., Santa Clara, Calif.,
one of several highflying new providers of high-speed Internet connections over existing telephone lines. The company staged a hot initial public offering in January, but company restrictions prevented the Wards from selling their shares until two weeks ago.
Thus, Mr. Ward could do little but watch anxiously as the skidding market threatened his longheld dream of buying his family's first
house before he turns 30. The couple had agreed to pay $231,000 for a five-bedroom house to be built in a subdivision in Stockton, 70 miles from work, where prices are a fraction of those in the Santa Clara Valley. Their nine-year-old daughter, Nikya, and four-year-old son, Julian, loved running up and down the stairs of the model home. The clincher for Mr. Ward: the 49ers football team, his favorite, hold summer training camp right down the street.
The Wards knew their $15,000 down payment would have to come from
selling some of their Covad shares. Mr. Ward, who joined Covad in
March 1998, says his order-processing job pays less than $40,000 a year. Ms. Ward joined the company two months later and now helps with
installing Covad equipment at local phone companies' central-switching
offices.
"We've been saving, but we never could have gotten to the down
payment," Mr. Ward says. "The stock put us in the ballgame."
Mr. Ward, who also wanted to buy his wife a new car and pay off his
student loans, says he had decided he would be happy if he could get $50 a share for the options he received as part of his hiring package.
The shares hit a high of $81 in April, but slid below $40 in a market slump in June. The hopes of the Wards were revived by a subsequent
stock-market rally and a favorable mention in Forbes magazine that sent the stock soaring 34% to $55.50 on June 30. It kept climbing, all the way to $68.125 on July 15. "I was wishing I could sell that day," he says.
He couldn't. Like other employees of companies in the IPO Class of '99, the Wards sweated out the "lockup," the six-month waiting period after an IPO during which insiders are restricted from selling their shares. Meanwhile, the Nasdaq underwent a correction of more than 10% and many Internet stocks fell more than 50% from their highs. Lockups are not required by law, but investment bankers have insisted on the restrictions as a standard part of IPOs to reassure outside investors.
With more than 150 Internet-related IPOs already in 1999, thousands of
employees are anxiously watching both the calendar and their Web-stock
tickers for their first chance to turn their paper wealth into real money. Insiders holding the huge crop of issues that went out in May and June must wait until the end of the year to find out what they're really worth.
'Collar' Their Gains
Meanwhile, aggressive financial advisers are circling like sharks, offering a variety of mechanisms that allow employees to secure their newfound riches before the end of the lockup period. For example, it's possible for some employees to "collar" their gains by buying options to sell their stock slightly below its current price after the lockup period ends. There are many variations on the scheme but all, in effect, represent a bet share prices will fall. In the case of top executives, such deals must be disclosed to the U.S. Securities and Exchange Commission. The moves, however, could send the wrong signal to investors, so employees at Covad and many other companies must sign agreements foreswearing the arrangements.
Mark Walsh, chief executive of VerticalNet Inc., a collection of
industry-specific Web sites based in Horsham, Pa., said one financial whiz who contacted him even proposed a scheme known as a synthetic collar, that promised to lock in gains in a way that did not have to be reported. "I walked out of the room," Mr. Walsh says.
Mr. Walsh has seen the face value of his stake, including options that are not yet vested, fall from nearly $110 million to $52 million as the stock dropped more than 52% from a high of $149 in April to $71 last Friday. He says he never believed the higher number, anyway.
"If a month ago I figured out my net worth and I really started to behave like that was the right number, I deserve to be beaten with a two-by-four," he says flatly.
In Covad's case, the lockup agreement restricted executives, directors, employees and early outside investors from selling shares or options on shares "in any manner" until Wednesday, July 21, the 181st day after the IPO. What's more, because the company was due to report second-quarter earnings on July 26, the blackout period was extended for employees until Thursday, July 29, to avoid any appearance of insider trading.
'It Doesn't Seem Real'
In the two weeks before the magic day, Mr. Ward and other Covad
employees checked the Web every few minutes as the stock fell from its
recent high, and kept on falling. "It was an emotional roller-coaster," says Brent Chapman, 31, Covad's director of technical marketing. "On paper, I lost a half-million dollars. It doesn't seem real. But it is real."
The most recent slide began in mid-July. By July 22, the stock had
skidded as low as $50 on the prospect of a wave of selling by institutional holders not bound by the earnings-report blackout period, and worse-than-expected results from Northpoint Communications Group, one of Covad's direct competitors.
On July 26, Covad reported second-quarter results that met analyst
expectations, even though losses expanded to $41.9 million from $28.9
million in the first quarter. The next day the stock rose as high as $58 before retreating again.
Two days later, with the stock at $54, Mr. Ward told his broker to sell a chunk of his shares the next day, the first day he was eligible. "I had a feeling it would fall a little bit" because of the expected flood of selling, he says.
Indeed, on Thursday morning, the shares opened at only $51.19. Still, Mr. Ward had hit his target and was finally able to relax. "This is like a dream come true," he now says.
But just barely. By the end of the day, the shares had fallen to $48; last Friday the stock closed at $41, down $1 and more than 49% from its high. No matter: the Wards plan to move into their new home when it is finished next spring.
To be sure, even the lower price still represents a tremendous windfall for the Wards and other early Covad employees, whose options were priced well below $1. When Covad's lockup ended, Tom Regan, 52, sold about 10% of his holdings for a price per share in the high $40s. "Whatever the price was fine with me," he says.
Buying a Viper
Mr. Regan says the proceeds allowed his wife, Cathy, to retire after 30 years as a nurse. After losing one sister to diabetes and another to cancer, Mr. Regan is also preparing to make substantial donations to fight both diseases. For himself, he bought a bright red Dodge Viper, a sleek sports car with a base price of about $67,000.
For those who mastered the intricacies of stock-option accounting, the low price represented financial opportunities. Mr. Chapman rushed to exercise as many options as possible. That started the clock running on the one-year holding period required to treat the gains from subsequent sales as capital gains rather than regular income, which is more heavily taxed. By exercising his options when the market price was low, Mr. Chapman minimized his immediate gains, and thus the taxes he will have to pay next April 15.
Rich Wong, 31, Covad's director of product marketing, says he used his
brokerage account to buy even more shares at what he considered a
bargain. If the company fulfills its potential, he says, Covad could someday be worth more than $30 billion, or about nine times its current value. "It's a question of, 'Do you believe?' " he says.
Mr. Ward believes. That's why he and his wife are holding onto the rest of their shares, he says, at least until the stock splits four or five more times. "Maybe someday I won't have to work anymore," he says.
For Covad's top executives, there is no choice but to believe, at least for one more month. As part of a secondary offering of shares, Covad's officers and directors, but not lower-level employees, agreed to extend their lockup period. For them, the game of waiting and watching continues until Sept. 16.
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