Earlie can you or someone take this post apart for me please.
I have a post from someone that Employee Options they do not
affect earnings at all, in fact I believe his conclusion
is that Buffet is mistaken and they are a good idea.
Thanks, appreciate it if you have the time.
There certainly has been alot of talk these days about getting rid of them.
Personally I think it would be devastating to earnings but
not sure how best to prove it. At any rate here is the post.
==========================================================
Option math
NoOptions Options
Revenues 5,000 5,000
Cost 2,500 2,000
Gross profit 2,500 3,000
Expenses 2,500 2,000
Operating profit 0 1,000
Taxes 0 300
Net Income 0 700
Shares outstanding 2,000 2,000
EpS 0.00 0.35
Options 1,000
Cash from options 1,000
Total shares 2,000 3,000
EpS after options 0.00 0.23
Share value (P/E=15) 0.00 5.25
Diluted share value 0.00 3.45
The NoOption Co. had to pay higher salaries to the
founders, $500 more to the CTO and $500 more to the CEO.
In consequence the company showed zero operating income,
zero taxes and zero net profit.
The options company saved $1,000 on salaries and agreed to
give options to the CTO and the CEO, 1,000 shares in total
at a strike price of $1.00. Since the company saved on
salaries it made $1,000 in operating income which caused
$300 in income taxes leaving a net profit of $700.
Since the company's shares typically sell at 15 times
earnings and since the diluted earnings were only 23¢
instead of the 35¢ without the options, the market values
the company's shares at $3.45. The CTO and the CEO
promptly sold their shares and netted $2,450 after paying
the strike price of the options, All in all, the CTO and
the CEO of the Options company made more money than their
colleagues at the NoOption Co.
NoOptions Options
Salary 1,000 500
Options (net) 0 2,450
Gross income 1,000 2,950
Taxes (20%) 200 590
Net 800 2,360
Almost three times as much!
So how did the shareholders fare? If the shares are valued
at 15 times earnings, the shares of the NoOptions Co. are
worth zero, zip, zilch! But at 15 times earnings, even
with dilution, the shares of Options Co. are worth 3.45.
Oh, I almost forgot the cash position, maybe it's here that
NoOptions Co. does better.
NoOptions Options
Initial cash 2,000 2,000
Less:
Salaries 1,000 0
Taxes 0 300
Sub Total 1,000 1,700
Plus:
Options 0 1,000
Net cash 1,000 2,700
Hmmmmm...
But Buffett says that options are bad. Beats the heck out
of me! What you pay in taxes for having a higher operating
income is more than offset by what you save on salaries.
The extra income that the optionees get comes from Wall
Street and not from the company's customers -- not from
revenue.
Of course, the diluted shares are worth less per share than
the "undiluted" ones but those undiluted shares are just a
convenient fiction for the option haters. If you have to
pay the salaries because you do not give the options, then
you never can achieve that "undiluted" status because you
simply have higher expenses. |
