What are threads for if not to help you over your concerns about WIND's R&D spending versus technology purchases. John and Tim provided excellent descriptions of the accounting issues justifying WIND's actions, and Jason has tried to convince you and Carolyn that the write off is of no consequence to the Street. I sense you know intellectually he is correct, but perhaps WIND's frustrating consolidation puts you in the mood to view outcomes negatively.
I discussed most of these issues when the thread debated why WIND issued the $140 million bond when it already had $100 million. I suppose it took a couple of actual purchases to breathe life into my abstractions. Let me try again.
Accounting standards simply establish boundaries within which management makes decisions about how best to run the company, including obtaining needed technology. Options are many, and each has implications for the current and future value of the company, not to mention the precious stock price. Successful technology companies develop strategies that provide access to as much R&D product as practical. Unfortunately, WIND cannot accelerate R&D spending much past current levels without the Street punishing the stock brutally. If the company capitalized a sizeable increase in R&D, the Street would accuse management of aggressive accounting to protect earnings-and punish the stock. If sizeable increases in R&D spending were expensed instead, then the Street would punish the stock because of lackluster earnings. In other words, the company simply has no practical mechanism to invest heavily in intramural R&D. Yet, the company has $200 million available to fund R&D, a very healthy cash flow, and it may want to develop or enhance products in most of its markets.
The Street understands this catch-22 and provides an escape. Purchase technology and, subject to accepted accounting procedures, the company can write off many of the expenses without fear of punishment. In virtually every case, it is safe to assume the purchaser gains in any arm-length transaction, adding value to each share of the company. (Full fledged acquisitions are a different matter, because the Street has learned that management often anticipates more synergy, and less difficulty, than justified.) If per share value is increased because of a purchase, there is no reason to punish the company, no matter how the deal is accounted for. Think about it. If Ron spends $1 million dollars in an arms-length transaction, why should the stock be punished?
It is reasonable to argue that capitalizing a huge R&D spending spree similarly has no net economic cost, because presumably benefits should at least balance amount spent. Indeed, that is exactly why capital spending has a miniscule impact on current earnings. The problem is that the Street finds it extremely difficult to monitor management performance if sizeable spending can bypass earnings, only to turn up later, squirreled away in assets. Consequently, the Street only politely accepts moderate capitalization of R&D, and distrusts abrupt changes from period to period.
Similarly, the Street will not ignore R&D expenses, by calculating a Growth Flow Ratio as advocated by Mike Murphy of the CTSL. Growth Flow degrades the essence of earnings, the Holy Grail of investors. Besides, if the Street ignored R&D expenses, what would keep companies from designating most expenses R&D, and win praise on the Street without ever producing real profits?
Since the Street ignores technology write-offs, WIND has no alternative for accelerating R&D but to purchase large R&D products from outside the company. Before you feel too sorry for management, however, you should realize that buying technology is an extremely efficient way to acquire compatible products. Some of the reasons are: (1) you get to see the product before the purchase, which you never can do with R&D, (2) you can put it to use as soon as the wrapper is taken off, which is never, never true with R&D, and (3) you don't have to waste scarce management resources supervising development, as you would if you invented everything in-house.
I wouldn't be surprised if WIND started investing (not an expense against earnings!) in numerous startup companies, nudge them toward technologies of interest, nurture them until they are ready to be hatched, then purchase and integrate them into standard products. This is an attractive way to assess potential employees, while side-stepping limitations of R&D. How better to delegate responsibility and to provide incentives than to set up an operation to function on its own. Survive and we will reward you with a takeover or an IPO. Fail and you are passed over.
Mitchell, what I am really trying to say is WIND management is doing everything exactly right. Not OK, not pretty good, not "let's forgive them this slip", but exactly right. It bothers me that you are expressing negative feelings about understated R&D and technology write-offs when you should be popping corks. Don't let the on-going consolidation get you down. These are happy times.
Allen |
