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Strategies & Market Trends : Gorilla and King Portfolio Candidates -- Ignore unavailable to you. Want to Upgrade?

To: techreports who wrote (48551)	11/4/2001 10:41:22 AM
From: Stock Farmer	Respond to of 54805

Techreports, reference Cisco's cash flow fueled by stock options. I covered this exhaustively over on the Cisco thread starting about a year ago. For a dramatic example, and forgetting the recent "blip", look in the 2000 10K. Released back when Cisco was "goin tooo-da-moooon". Under statement of cash flows. Subtotal: "cash flow from operating activities". Change from FY 99 to FY 00 was 1,816 M$ on a base of 4,325 M$ or 42%. Pretty impressive. Now dive inside this subtotal. Note the line entitled "Tax benefits from employee stock option plans". Change from FY '99 to FY 00 was 1,658 M$. That 1,816 M$ gain doesn't look so impressive any more. Excluding stock options in both years, operating cash flow grew by a whopping 4.5% Of course, operating cash flow is subject to a host of misleading effects when one reporting period is examined in isolation. Merely increasing or decreasing AR or AP or a host of other accounts in the business cycle generates "operating cash flow" that isn't profit. It washes out over time, but the feedback cycle is generally too long for investment decisions. I will caution that this is very superficial, only intended to illustrate the point. An exhaustive treatment shows that it is correct over the long run (hint: look at the never discussed statement of comprehensive income). Make no mistake about it though, stock options are a vitally important element of the cash flow for high tech businesses. Something to watch out for when performing a valuation exercise. John.

To: techreports who wrote (48551)	11/4/2001 5:33:41 PM
From: Stock Farmer	Read Replies (1) \| Respond to of 54805

re: How fast would Siebel have to grow profits for the next 10 years... A good practical valuation exercise. Start with recent performance. Latest 10Q shows Earnings of 153 M$, D&A of 47 M and PP&E expense of 172 M$ for an adjusted free cash flow of 18 M$/six months or 36 M$/year. Previous 10K shows 221, 51 and 152 for net 120 M$ FCF. So we are safe to peg FCF somewhere between 40 and 120 M$/y as our starting point. Let's use 100 M$ to be on the generous side. Next it's a good idea to factor in dilution. Siebel hasn't been parsimonious with stock options, and dilution has been running at an astounding 10%/year. Let's assume the insiders get a smidgen less greedy and use 6% as the average go forward rate. Next, what kind of return do we want? Well, we are asking the question "is SEBL a good investment". So we mustn't be satisfied with anything less than a T-bill which is the risk-free alternative. Let's call it 6%. Throw all of this into an excel spreadsheet. Using a trial growth rate, calculate profits in year N, reduce to present value and divide by shares in year N. Sum. Answer? If we are absolutely positive the company grow will grow profit by 53% per year from 100 M$/y and only dilute shareholders by 6% per year, then the next 10 years' profits would add up to $17.53 (discounted at 6% per year). Of course, 53% growth for 10 years implies profits in year 2011 of about 7 B$/year. In context, that's a smidgen less than the accumulated earnings of Cisco over its entire history as a public company. So IMHO, the likelihood of achieving this is, achem, dim. Of course, if I plug in numbers like 11% for the desired rate of return (getting T-bill returns isn't exactly what GGame investing is all about) and use a historical 10% for dilution and estimate a less surreal sustained 30% rate of growth of profits... well, holding a long position with a basis in double digits doesn't look very attractive. Now, I'll be the first to admit this is an overly simplistic and flawed way of computing a fair value. But the conclusion turns eyeballs in an unaccustomed direction. John