Wednesday, April 06, 2005

The Hidden Cost of Being a Shareholder

Give IBM credit.

After years of fiercely resisting stock option expensing by most Silicon Valley companies, IBM steps forward and announces plans to do just that.

The magnitude of the deception by which companies—both high-tech and not—handed out stock options to reward employees without reducing “expenses” for purposes of the almighty “Earnings Per Share” calculation has always been easy to calculate from the footnotes of the offending companies.

The offending companies, however, persisted in looking at things the “pro-forma” way, options excluded, and Wall Street mostly obliged, despite the fact that the whole point of reported earnings is to calculate the amount of income left over for...shareholders.

The cleverest ruse of all may have been perpetrated by Dell, which not only grants stock options up the proverbial wazoo, but then boasts to Wall Street about the massive share buybacks it undertakes as a vote of confidence in its own shares.

The fact is, Dell has to buy back massive amounts of stock simply to offset the extra shares created by option exercises: all that money spent to buy back shares in the marketplace simply means Dell is running in place. The cost of “running in place” now approaches a billion dollars a quarter, for Dell. And it is many billions for other companies, Cisco included, that are also hooked up to the option-grant-intravenous-line.

The notion that employee compensation in the form of stock is somehow different from cash and therefore not reportable on the statement of income leftover for shareholders is, and always has been, a scam; and it only took a major bubble, dozens of bankruptcies, and billions of dollars lost by investors to force a change.

But better late than never.

As a result of IBM’s willingness to come forth and expense the cost of option grants properly, we now learn that IBM’s earnings available to shareholders are 10% lower than previously expected. 2005 earnings estimates are going from the $5.60 a share range to the $5.05 range, using the Bear Stearns numbers.

Think of that 10% this way: it is the hidden cost of being an IBM shareholder.

Jeff Matthews
I Am Not Making This Up


Chris Fischer said...

The scary part is, IBM is one of the more honest tech companies. I believe IBM now actually issues their options grants with a strike price 10% higher than the current share price, which makes the options worth a good deal less. They do, however, have a massive pension obligation that they're being less than upfront about.

Companies like Yahoo amaze me. After their CEO cashed in $230 million worth of options last year, they dolled out another boatload to him this year, and they justified it by saying that someone was going to "snatch him away". Uh-huh. I'd like to hear who.

Yahoo actually has some cash right now because they sold their google stake worth somewhere in the 2 billion range, so what do they do? Buy back stock - again, the same stock issued via options. And again, they play this up like it's a great thing and they have confidence in the company, etc., when it's really there to hide the executives looting via stock options. I can't wait until the first earnings report after June.

MD said...

Dell's buybacks have cost the company $8.5 billion over the last three years, yet diluted shares have only decreased by 76 million. Given that the stock has probably averaged $30 over that period, only about $2.3 billion of that massive buyback was used to actually reduce shares -- the remaining $6.2 billion was really just unaccounted for compensation expense.

That $6.2 billion is huge when you compare it to the $7.8 billion in net income that Dell has produced over the last three years.

MD said...

After seeing that Dell's share buybacks reduced diluted shares by only 76 million, I was curious to see how much Michael Dell has sold in the last three years -- around 100 million shares by my reckoning, which may be low because Michael Dell gets options. Yes -- a 10% owner gets stock options.

So the company hasn't even reduced the float in the last three years despite spending $8.5 billion in buybacks.


YosemiteDan said...

Employee Stock options are the preverbial misdirection. Watch one hand while the other is taking money out of the shareholders pockets. It is amazing how much money companies use to buy back shares, but the float continues to grow. Where is the value in that?