From this week's Barrons, Up and Down Wall Street.
Even shares of mighty Cisco -- the No. 1 supplier of networking gear for the
Internet -- have caved. No matter that the San Jose-based firm is still posting
stellar results. In its first fiscal quarter, ended October, on 66% higher sales,
reported net soared 90%.
Yet, the stock, which traded as high as 82 less than a year ago, recently
changed hands below 32, and currently fetches 36 and change, giving the
company a stock-market value of about $265 billion. Quite a comedown from
last spring's roughly $570 billion.
Investors, it appears, have finally embraced the eminently sensible notion that
with any number of Cisco's customers seriously ailing and others
understandably concerned about the slumping economy, prospects for Cisco
itself are likely dimming.
That its stock price has been cut in half is doubly bad news for a company that
has relied heavily on that loftily priced currency to enhance earnings.
As Barron's readers may remember, that was precisely the subject of a critical
piece in this magazine last October, written by the renowned accounting expert
and valued Barron's contributor Abraham Briloff.
Abe, as he's affectionately known in this shop, zeroed in on Cisco's accounting
for pooling-of-interest acquisitions and for employee stock options. While
meeting the not overly exacting standards of GAAP, which the company rightly
said it has no choice but to follow, Cisco's accounting in both cases, Abe
argued, had greatly inflated reported earnings.
His essential gripe with Cisco swapping its fancy-priced stock for shares of
other high-tech outfits and accounting for the deals on a pooling basis was that
the company thereby suppressed enormous costs that never passed through the
income statement.
Thus, in the two fiscal years ended July 2000, he estimated that by using pooling
accounting for a string of acquisitions, Cisco had masked a grand total of $18.2
billion of costs. Not exactly small potatoes for a company that last fiscal year
had sales of $18.9 billion.
His second complaint was the manner in which Cisco accounted for employee
stock options. The underlying reality here is that folks are willing to work for
pretty modest salaries if they're making millions off their options. Abe contends
whether employees are paid in dollars or options, those costs should be
recognized.
Specifically, when an employee exercises an option and, in the process,
generates a tax benefit for his employer, the employer should then expense the
amount of related compensation (net of the tax benefit) as a cost of doing
business. Abe calculates the imputed cost of employee stock options based on
the actual tax benefit from those options the company shows in its cash-flow
statement.
Had Cisco expensed these costs in this fashion in fiscal 2000, ended July,
instead of reporting income of $2.1 billion (exclusive of nonrecurring gains on
investments), the company, according to Abe, would have shown a loss of $363
million.
The same accounting approach distorted results in the first quarter of this fiscal
year.
To wit: In the three months ended October, on $6.5 billion of sales, Cisco
reported earnings of $798 million, or 11 cents a share, compared with net of
$415 million, or six cents, in the year-ago span.
But this year's first quarter included $190 million of "net gains realized on
minority investments," which compares with no realized gains last year.
What's more, Abe figures the imputed after-tax cost of employee stock options
amounted to $2 billion in this year's first quarter, versus $780 million in the same
span last year.
The bottom line: If you exclude one-time gains and include Abe's imputed
expense for stock options, Cisco would have lost $1.392 billion, or 18 cents a
share, in the October '01 quarter, compared with a loss of $365 million, or five
cents a share, in fiscal '00.
Cisco's stock has been cut in half. It boasts a neat franchise and a debt-free
balance sheet. But shares at under 37 are still going for an astonishing 12 times
sales and 90 times reported earnings.
A very rich multiple even if, generous to a fault, you believe those reported
earnings are the real thing.
Which, as all the foregoing demonstrates, Abe makes an excellent case they're
decidedly not. |
