Huey - Yes, you are closing in on the truth of the matter.
And it is even more astonishing than you might believe.
Let's actually do all of the math and lay it out for the thread, one more time.
Start with a naive version of free cash flow, forget options, forget equity financing. Let's use data from FY '06 through FY '02 as published in the 10-K available from EDGAR.
Year Revenue Earnings D&A Capex Naive FCF
(CF.ops) (CF.inv) (E+D&A-Capex)
FY 2002 18,915 1,893 1,957 2,641 1,209
FY 2001 22,293 -1,014 2,236 2,271 -1,049
FY 2000 18,928 2,668 863 1,086 2,445
FY 1999 12,154 2,096 486 584 1,998
FY 1998 8,459 1,350 327 415 1,262
FY 1997 6,440 1,048 212 331 929
FY 1996 4,096 913 132 283 762
Total 91,285 8,954 6,213 7,611 7,556
So an unsophisticated retail investor would conclude that Cisco is an economic powerhouse that has returned 7.5 Billion dollars to its shareholders in un-polluted, non-fudgeable pure "free cash flow".
But lurking just below the surface there is something wrong. Things don't quite add up.
Look at the total depreciation: 6,213 M$. Look at the total expenditure on cash capex: 7,611 M$. The difference is a respectable 1,398 M$. That means we should expect to see capital assets in FY 2002 of 1,398 M$ more than they were at FYE 1995, which was 137 M$.
Take capital then, add more between now and then, have some depreciate... this has to add up to what we have today. In other words, the total should be 1,535 M$.
But it isn't. Lo and behold, depreciable assets are 8,464 M$ (Property plant and equipment alone is 4,102 M$)!! Obviously, the company somehow spent 6,929 M$ that didn't show up on the cash flow statement. No mystery, it was purchased with non-cash. With shares. Remember all those acquisitions?
So we shed a bit of naivete and factor this in:
Reported Revenue 91,285
Reported Costs 82,331
-------------- -----
Reported Earnings: 8,954
Add Back Depreciation 6,213
Minus Cash Capex (7,611)
Minus NonCash Capex (6,929)
=================== =======
Total Wealth Creation 627 M$
Check:
Assets '96 137
Plus Cash purchases of Capital 7,611
Plus Noncash purchase of Capital 6,929
Minus Depreciation (6,213)
------------------
Expected Capital Assets 8,464
Subtract Capital Assets '02 (8,464)
=========================== =====
Capital Not Accounted For 0
Nothing up the sleeves, pretty straight forwards, actually. However, a mere 627 M$ in wealth creation is a far cry lower than what less sophisticated investors might have calculated. What does this mean? It means that while the company is earning more than it costs to make stuff, in order to do so the company has had to invest the difference in necessary capital along the way. There really wasn't a lot of "discretionary" capital expenditure going on after all. Ergo, there wasn't all that much room to pay shareholders something back in return for using their capital!!!
And this is before any distortion introduced by stock options. Let's work out what shareholders have paid into the enterprise that's earned them back 627 M$ in profit.
The company doesn't report this amount. Yet. And if they have their way they won't, ever. For good reason. However, because we know a thing or two about finance, we can figure out how much employees scampered away with. One way to estimate this is by looking at what the company got back from the IRS as a tax deduction, factored by the tax rate. Let's assume a 35% tax rate for the company and add up the tax benefit:
Year Tax Benefit from
Employee Stock Options
1996 198
1997 274
1998 422
1999 837
2000 3,077
2001 1,755
2002 61
Total 6,624
Tax rate 35%
Pre-Tax Benefit 18,925
Again, no magic. Just common sense. It's pretty clear. Regardless of what estimate we might have computed using Black-Scholes (which is probably a different number), over the past few years insiders have actually scampered away with 18,925 M$ in non-cash compensation. Which was actually paid by shareholders.
So let's put the whole picture together:
As Reported Revenue 91,285
Minus As Reported Costs (82,331)
Minus Unreported Compensation Cost (18,925)
Add Back Depreciation 6,213
Minus Cash Capital Expenditure (7,611)
Minus Non-Cash Capital Expenditure (6,929)
Total Wealth Creation To Date (18,298) M$
Anybody should be able to take a total of 18 B$ from a bunch of suckers and build up an enterprise that will give 'em back 2 B$ a year for a decade or so. I could do it with T-bills. You could too.
It takes absolutely brilliant management, however, to convince the planet that such an enterprise represents an economic powerhouse and get folks to value it at a hundred billion or so. These folks clearly deserve billions and billions in compensation. Please pay up.
John |
