Let me cut to the chase: If you are a shareholder of Concord Communications
Yeah, you heard me. Want some other words? You're the sucker at the table, you're the bait, you're the mark. And if your name is Mark, then you're "Mark the mark."
I know, that's not a very nice thing to say. My treatment of Concord shareholders, however, simply pales in comparison to how, at least in my opinion, the company itself is treating them. I thought that the folks at Fog Cutter
Concord Communications, like many companies, grants stock options to employees. They do this, you know, to align their interests with that of shareholders. Concord grants a lot of options, with the total potential dilution to shareholders in the last three years being 5.6%, 5.5%, and 5.4%. This means that the poor benighted shareholder who has owned Concord shares since 2000 has had to endure potential dilution of his stake by 17.4% over a three-year period. I tend to put an absolute ceiling of 3% dilution on stock option grants, and even then the investment case would have to be stellar to get me to bite the bullet. Dilution of this sort is what drove me away from eBay
Basically, Concord Communications has elected to repurchase options from employees that are priced anywhere from $25 up to $60. These options are deeply underwater, meaning that it is unlikely that employees would ever see a penny from them. In other words, for the employees, this is an otherworldly good deal.
So what if they're worth nothing?
So I ask you, master option pricing guru. Concord's share price is at $9, and its earnings and cash flow performance have charitably been lukewarm. How much money would you pay for an option to buy Concord's shares at $40 at any time over the next five years? Would you pay $0.05 per share? How about $0.10 if you're feeling saucy? Concord Communications is willing to purchase its employees' options at a price of $4.07 for ones priced between $25 and $30 and will pay $2.76 for any option that is priced at $60 or up. By my reckoning, the company is overpaying for each option by about 2,500%. Why would a company do such a thing? Its email to employees offers some clue.
"One of the ways we attract and retain top talent as well as ensure that our employees' interests are aligned with those of our stockholders is to offer stock options," says the email, disclosed in a company filing from September 27. Now, I may be dense, but unless the company is out there actively soliciting shareholders to repurchase stock they've held from the year 2000, I cannot for the life of me see any alignment between shareholders whose principal value has been mauled and a generous repurchase plan such as this. In fact, this highlights one of the basic problems with stock option programs. This is supposed to be a variable compensation program, the risk of which squarely resides with the holders of the options. If the company fails to perform, then their options are supposed to be worthless. Ah, but according to Concord's filing, since their stock has declined, the options they granted at $25 and above "are not achieving their intended purpose." What purpose is that? Options are not guaranteed payment. If the company fails to add value, you're damn right that a pile of worthless options have done exactly what they were supposed to do.
This is why we have so much of a problem when companies such as Siebel
"'Repricing' existing options would result in our being required to use variable accounting methods for those options. The variable accounting method would require us to record, in our financial reporting, compensation expense each quarter until the repriced options are exercised, terminated, or otherwise expire. The higher the market value of our shares of common stock, the greater the compensation expense we would have to record. In addition, a 'repricing' would require us to obtain shareholder approval, which is a time-consuming and costly process." (Emphasis added.)
The company didn't want to just reprice these options, since doing so would require it taking a hit to reported earnings. Further, repricing requires a shareholder approval, which the company claims would be expensive. I would also like to add that even shareholders as put upon as Concord's, one would hope, would tell management to go pound sand.
In my view, this logic is simply frightening. We don't want our earnings to look worse, so we're going to go another way and pay for these options directly out of shareholder equity. Aaaaaargh!!!! Here's a hint that we've made regarding other companies, most recentlyKrispy Kreme Doughnuts
But wait, there's more. The company also notes that it would not have to report increased diluted share count if it just reprices and then grants additional options for compensation, so in management's determination it's better just to buy back these options at inflated rates. In addition, management notes to employees that this is a really great idea because those same shares would then be available for future option grants, because the company has limited ability to grant options under existing plans. Shareholders thus are given the hint that the shares underlying these options that are being repurchased have already been earmarked to be granted again in the future, this time at much lower strike prices.
Here's the most important part of this particular exercise. As I noted earlier, Concord is a big-time serial option grantor -- it doles out options each year that comprise a large percentage of its existing float. Its share price spike above $40 was by and large contained in one calendar year: 1999. A quick look at the company's proxy from 2000 shows something that perhaps should be unsurprising: The top five executives at the company as a group received more than 40.6% of all options granted in 1999. CEO John Blaeser received more than 13% by himself. These are the people upon whom shareholders depended the most to perform, and they've failed miserably. What's the solution? Yeah, let's cash them out of those options, obviously.
It's not like the stock has been on a gradual descent, making subsequent options worthless, either. In October 2000 the stock lost more than 65% of its value in a single day. A look at the proxy for that year shows something interesting: Many executives received options grants after the stock was decimated. One hundred percent of Blaeser's option grant came at a strike price of $6.68, never mind that the company's stock traded lower than this price only 10 times through the entirety of 2000. Options in subsequent years were granted at prices close to today's share price. Blaeser has been granted options on 400,000 shares since 2000, with strike prices ranging from $9.01 to $14.65. These grants, by the way, come after a reasonable shareholder would look at the performance of the company and wonder just what good Mr. Blaeser's stewardship of the company has done for them.
To me, it's as if management sees this short period's worth of options grants and can't stand the thought of getting nothing for them. Never mind that's how much the options are worth. So to solve it they put out a document offering to repurchase these options, you know, for the sake of the employees and shareholders alike. They don't want to go the route of a repricing, because it looks bad from an accounting perspective. So they come up with a plan that I'd imagine that the accounting pooh-bahs had never thought of, because it is so boldly counter to the principles of good governance.
Well, fellas, I give you Concord Communications, a company that seeks to align its employee interests with that of shareholders by buying back options at obscene premiums to their value. That's a definition of "align" that I have never, ever considered. These shareholders have been abused for years, all for miserable performance. Anyone sticking around after this latest expropriation of their investments really has no one else to blame.
For more Foolish coverage, see:
- Warren Gump's Should Management Profit From Screwing Up?
- Whitney Tilson's Stock Options' Perverse Incentives
- Bill Mann's What's a High P/E?
Care to invest in companies that pay their shareholders, not the other way around? Take a free trial of Mathew Emmert's Income Investor, and learn each month about some exciting dividend-paying companies.
Franz Ferdinand. Righteous. Bill Mann prefers to own companies that treat shareholders like partners. In this game of "one of these things is not like the others," he holds shares in Berkshire Hathaway. The Fool has a disclosure policy.