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Technology Stocks : Cisco Systems, Inc. (CSCO) -- Ignore unavailable to you. Want to Upgrade?

To: Jorj X Mckie who wrote (48895)	2/12/2001 11:27:07 PM
From: Wyätt Gwyön	Read Replies (1) \| Respond to of 77400

the effects of dramatic decrease in stock price in the context of employee stock option tax benefits (to Cisco) should have been visible in the very short term. There is visibility, but perhaps in a different way than you'd expect. Perhaps counterintuitively, the rapid fall in Cisco's share price has boosted their cash flow. For example, Cisco's tax credit in the most recent fiscal year was 2.5 billion, several times greater than the year before. This implies that employees exercised a lot of options as they saw the share price start to tank. This presumably applies mainly to those with deep-in-the-money options. Eventually there won't be any of these options left, so their contribution to cash flows will be of limited duration (if the stock does not go back up). if proceeds from investments in companies were based on the bloated stock prices, the decrease in those stock prices should also have an immediate effect. If you are talking about an effect on "earnings" or "cash flows", remember that paper gains do not show up there. It is the realized gains from minority investments one would look for on the C/F statement. A drop in paper gains would only be found, if they in fact break it out, on the balance sheet or the notes to it (or maybe in management's discussion). I'm not sure how Cisco handles this. Wasn't the argument that these things were positively impacting the earnings statement? The question is (in relation to cash flow again), how much does Cisco have left in the hoppers. Those would be the hoppers of Unrealized Gains and Unrealized Options Exercises (and the Attendant Tax Credits). The other, indirect way the earning statement is affected is the extent (perhaps not measurable) to which employee cash payments are reduced by options grants. The other other way the earnings statement benefits is that Cisco writes off all those M&A costs on a regular basis in the pro forma number (the one Maria tells you about), even though M&A seems a core part of their business. Their pro forma number would be a lot lower if they did not add back these expenses.

To: Jorj X Mckie who wrote (48895)	2/13/2001 12:03:36 AM
From: Stock Farmer	Read Replies (1) \| Respond to of 77400

Hi Jorj - I sympathise with lack of accounting background. These guys can spin your head faster than a poltergeist. Normally, a company's economic value depends on its free cash flow. The more cash, the higher the valuation. Also normally, a company grows by investing capital. This drains cash. A company can drain cash faster than it comes in from earnings from operations... but only temporarily. In Cisco's case, option exercise in the presence of rapidly inflating stock price generates a cash windfall which has two positive effects. First, it allows Cisco to spend more cash for growth without generating a negative cash flow. Secondly, it shows a larger free-cash-flow than the "core business" can sustain, which inflates the FA based valuation of the firm. Spend more, grow more. So CSCO is not only apparantly able to grow faster than comparators, it is also more highly valued because of a larger free cash flow? Cool. These two effects conspire to increase the stock price... which increasess the benefit... which increases the apparant value... which increases the stock price and so on. Small wonder we saw the stock go up more than 1000 x while earnings went up only 200 x. What happens if the option benefit reduces? Start with earnings. Nothing happens right away. Revenue growth and earnings growth come from harvesting prior investments. So there is a time lag. This quarter's revenue growth was set in motion and paid for some months ago. It is future growth and future earnings that get slowed down. Like an inventory glut, it might take 6-9 months to work its way through the system before it is fully felt. Even then, it is usually indirect and next to impossible to attribute to cause. The board doesn't often come out and tell you what strategic investments it has decided NOT to take! A revenue or earnings growth hit doesn't have to happen either. The company has a huge cash reserve. It can declare this crisis temporary - a rainy day - and dip into the cash set aside for this purpose. Spend from cash on hand instead of the cash it's been getting from employees & the IRS. This is a cash flow impact, not an earnings impact. You could add years to the picture this way. So you must wait a year or more before you will see anything in the earnings statement. Nevertheless, once it starts it is just as evil to the downside. Stock goes down, benefit goes down, cash flow looks pathetic, drives stock down and so on... This is why it is imperative to watch cash flow like a hawk. As to impact of earnings from investments? If they are earnings, they are likely dividends. The underlying equity may have been choked in half, but if it is paying a dividend, you'll see the income unchanged. So, in summary, these things positively affect earnings. But in the future. Current impact will be seen only in the cash flow statement. That's why I watch it so closely. John.