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Of the 10 companies whose stock-based compensation over the last 12 months is 100% or more of operating cash flow, the final three don't even come close to a passing grade in my book. By adding back stock-based comp, they may accurately reflect that it doesn't cost them any cold hard cash today, but it implies that it won't have a huge impact on the future. Yet stock-based comp represents an IOU, and when options are eventually exercised, investors get diluted.
And now the top three offenders, where "top" is the worst designation:
Cash Flow Statement (all TTM, in millions, and rounded)
No. 3: Atlas Energy
No. 2: Youku Tudou
No. 1: Fortress Investment Group
|Stock Based Comp as % of OCF||392%||529%||903%|
|Earnings per Diluted Share||($0.46)||($2.82)||($3.46)|
Source: S&P Capital IQ, data as of market close, Sept. 24, 2012.
No. 3: Atlas Energy LP (NYSE: ATLS )
Atlas is the general partner for two other companies with attractive businesses: Atlas Pipeline Partners (NYSE: APL ) and Atlas Resource Partners (NYSE: ARP ) . Atlas Pipeline is a dependable tollbooth, caring not which energy car -- oil, natural gas, or natural gas liquids -- passes through, so long as it collects the toll for passage. Atlas Resource has moved into some of the most important natural gas plays in the country: Mississippi Lime and the Utica and Marcellus shales. Both send cash up to the GP, Atlas Energy.
But what then does Atlas Energy do with the cash? As holders of limited partnership interests, investors have limited power over a general partner in this structure, with few rights to stand against management's incentive to feather its nest to turn it into a bird mansion.
Here, note stock-based comp at 392% of OCF. True, the GP-LP structure makes this number not so simple and OCF more confusing, but not enough to move us from strong advice. Atlas Energy essentially issues options to itself -- IOUs that, while they have no current cash value, just put off taking your cash in the form of dilution ahead. No wonder a recent company presentation is all about Atlas Energy's two units and not about what the GP -- Atlas Energy -- does for shareholders.
Investors, I advise you stand not on Atlas Energy's shoulders.
No. 2: Youku Tudou (NYSE: YOKU )
I wouldn't recommend that Youku Tudou, an Internet television company in China, be on any investor's list. Red-hot annual revenue growth hasn't brought positive earnings per share or EBITDA, let alone the types of cash flow we prefer to see.
Why does anyone invest in China at all today? Apart from the lack of transparency across many Chinese small or slightly larger caps, why invest in a country with a regulatory structure that, if it exists in more than name only, has a fraction of the experience of the U.S., let alone Canada or any other developed country? Where the interrelations between the government and business are fraught with conflict and capital funneled directly or indirectly through central planning? Where the short-seller and Hong Kong-based Muddy Waters' investigative resources reveal acquisitions rife with conflicts and poor values for shareholders, such as at Focus Media -- a media advertising company that Muddy Waters noted bought a ginseng planation from employees?
And if all that isn't enough, management granted stock-based comp stands at 539% of OCF. Investors, if I were you, I'd have nothing to do with Youku Tudou.
No. 1: And now, the cherry on top: Fortress Investment Group (NYSE: FIG ) . This asset manager comprises private equity, hedge, and credit funds. Traditional valuation measures are tricky with such companies because private equity valuations depend on what management discloses, how markets shift for the portfolio company and its industry, leverage, and more. What times tangible book value should it sell for, based on what valuation of the assets? Do you have any say as a shareholder? Can an activist enter and agitate for better treatment? With Nomura Securities, at 28%, the largest owner, and Japanese companies hardly known for their activism in a nation of corporate interrelationships where a popular proverb says "The nail that sticks up is hammered down," I wouldn't go there.
Care not a fig for this fortress, which protects only management.
End of our countdown
This week, I've presented 10 companies that issue stock-based comp ranging from 119% to -- it can hardly be believed -- 903% of OCF. This is a bright, waving red flag to run, and it's not as if 75% or 50% is any better.
As I see it, you should seriously consider avoiding or selling these stocks. If you are experienced in shorting, which means analyzing shares short as percentage of float and days to cover, you may even wish to short some of the top 10 in search of profit.
Lose less, make more. It's as simple as that.