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To: Uncle Frank who wrote (50490)	2/24/2002 10:56:21 AM
From: Mike Buckley	Respond to of 54805

What's your take on this issue, Pirah? Great question, Frank. I look forward to his answer to see if I've got a handle on the subject. --Mike Buckley

To: Uncle Frank who wrote (50490)	2/24/2002 12:49:26 PM
From: EnricoPalazzo	Read Replies (2) \| Respond to of 54805

Party 1: A quick scribble with a pencil shows a fair market value of these printed certificates of $10,656 Millions. Yet they recorded only $3,112 Millions in Paid In Capital. The other $7,544 Millions never appeared on the balance sheet by a trick of the accountant's pencil. It just vanished because it left the company as soon as it was received. Party 2: The $3,112 million in paid in capital represents the strike price of the option grant. That is what the company received for those shares, and what should appear on the balance sheet. The $7544 million represents the stock price appreciation from the time of grant to the time of exercise, this is not a cost to the company or shareholders. If the option strike price is a discount to market price at the time of grant, that difference dilutes shareholder value. Pirah I ain't, but here's my take. Party 1 perspective is sort of right, but sort of misleading. Stock options cost $7 billion precisely because the stock has appreciated so heavily, so it's not as bad as he makes it out to be. Party 2 is nuts. If stock options had no value, employees wouldn't be taking them. Anybody who has written or bought at the money call options knows this. There are two questions we really care about. 1) what impact does issuing stock options today have on returns in the future? 2) How should we account for currently outstanding stock options in valuing a company. The answers to both questions are fairly simple. 1) Issuing stock options have a very similar impact to issuing stock. If you give out 10,000,000 stock options, you're expecting that eventually say 60% of those will be exercised for the current stock price. In other words, this is virtually identical to selling 6,000,000 shares of stock to the public. It turns out that it's slightly better, because of the tax advantages, but they're similar. As stock pickers, we should take the percentage of the float that's issued each year, discount by maybe 40% (for employees who quit before stocks vest or are in the money), and account for a dilution of that amount every year. 2) If we know how many options are outstanding, and what the average strike price is, we should decrease our value of the company by: number of options outstanding * (value per share - avg strike price) * 65% The 65% is because employers get back the tax that employees pay on stock option exercises, which is probably about 35%. At the end of the day, I think the clamor about stock options is a bit overdone. Even for companies like Microsoft, with heavy option exposure, the "debt" from oustanding stock options is only about 20% of the total value ($60 billion for MSFT). Likewise, dilution per year due to stock options is probably around 3% for these companies. The fact of the matter is, high tech companies cannot survive without giving out lots of stock options. And If I'm going to put money into a high-tech company, I expect annual long-term returns to dwarf the 3% per year dilution anyway. (Just ask people who bought MSFT & CSCO in the early 1990's if they're upset about the stock grants). Ethan

To: Uncle Frank who wrote (50490)	2/24/2002 3:14:48 PM
From: Stock Farmer	Respond to of 54805

Hi uf, how should we answer the skill testing question: What's the difference between the following two transactions: (a) Issue 10 Billion in shares (b) Sell 10 Billion shares to the public for 10 Billion (c) Purchase 7 Billions worth of after tax goods and services from employees and bankers and so on Versus (a) Issue 10 Billion in shares (b) Give 10 Billion in shares to insiders and bankers and so on in consideration of 7 billion in after tax goods and services delivered (c1) Receive the 3 Billion in difference owing, net of tax (c2) Have these insiders sell their shares to the public for 10 Billion Answer? Nothing but the accounting. The actual economics of the two transactions are identical. In both cases, the company parts with 10 Billions and receives 7 Billions "worth" of activity (assuming fair value is received) and 3 Billions in cash. Now the skill testing question: If we were to compare a company with the first accounting to a company with the second accounting, which one deserves a higher market cap? I'd enjoy your answer, as well as Pirah's.

To: Uncle Frank who wrote (50490)	2/26/2002 1:04:14 AM
From: Pirah Naman	Read Replies (1) \| Respond to of 54805

Frank: you may have missed this exchange between two parties on the qcom thread regarding the dilutive nature of stock options. I did miss it. The company should only show the [option price x number of options exercised] as paid in capital. There is no discernible net cash flow in either direction from the difference between the share price and the option price. If the option price is less than the stock price at the time then yes there is dilution. There is a cost associated with that dilution to the shareholders, as the dilution reduces the size of the future free cash flows accruing to each share. The cost would be the difference in the values of the [pre-dilution and post-dilution] streams of free cash flow. What bugs me is when the tax benefits of this kind of thing are included in income, and in that part of the cash flow statement that is for operating cash flows. IMO this belongs in the financing portion of the cash flow statement. The inconsistency on the earnings statement is well documented so I can't add anything there. - Pirah