Telecom's stock-option headache
Growing pressure to account for options as expenses could further damage industry bottom lines
by John Filar Atwood, equity research columnist
Riddled by massive debt loads, dreadful investor sentiment, and an ongoing slump in demand, telecom execs don't need another headache. But it looks like they might soon get one, and from an unlikely source.
Coca-Cola (KO) announced last week it would begin accounting for stock options as an expense. Analysts say that Coke―joining other S&P 500 players Boeing (BA) and Winn-Dixie (WIN)―has the clout to force other large corporations to follow suit. "Coca-Cola's status as an American business icon will catalyze business leaders to react," says SoundView's Jordan Rohan.
William Kidd of Lehman Brothers agrees. "Others are likely to follow suit, though most corporations are naturally resistant to such a change, thinking that it will eliminate the efficacy of options," he says.
He adds that what currently amounts only to peer pressure may soon become a requirement, because Congress is currently considering legislation that would permanently change the accounting treatment of options.
The bottom-line effects of such an accounting change could be dramatic on the ailing telecom industry, analysts say. Merrill Lynch's Tom Astle says that if the new options accounting were applied to 2001 results, CIENA (CIEN), Finisar (FNSR), and JDS Uniphase (JDSU) would have taken a major hit to pro-forma earnings.
"2001 options earnings for CIEN, FNSR and JDSU would be reduced by 170 percent, 100 percent, and 75 percent, respectively," he says. "Another way to look at it is that option cost alone would be 21 percent, 13 percent, and 17 percent of 2001 revenues, respectively."
Kidd adds that satellite companies also would have been affected. Treating options as an expense in 2001 would have reduced the sector's earnings per share by 14 percent, he noted. He says EchoStar (DISH) appears to have the least exposure to an accounting rule change, while companies with liquidity problems like Pegasus (PGTV), Sirius Satellite (SIRI), and XM Satellite (XMSR) would be more vulnerable.
Lehman analysts Stuart Jeffrey, Tim Luke and Steven Levy report that within the large-cap telecom equipment group, the impact would have been felt the most by Cisco (CSCO), Lucent (LU), and Nortel (NT) in the U.S. and Alcatel (ALA) and Nokia (NOK) in Europe. They recommend that investors monitor the size and frequency of future option grants at each of these firms.
Reports for further inquiry
Telecom equipment: Option accounting impact in communications equipment
Wireless equipment and data networking: Option exp.-assessing potential impact
However, they also caution investors not to over-emphasize the effect of an options accounting change because they believe the impact of stock option expenses will fall going forward.
"Companies will likely have at least 18 months to adjust compensation policy and behavior" to mitigate the impact of the change, they write in a recent report. For example, they believe companies may grant fewer options as part of employee compensation packages, or extend option vesting periods to spread the cost over a greater period.
They note that during the late 1990s, telecom equipment vendors used options as sweeteners in technology acquisitions. Those acquisitions will be far less frequent, in their view, further dampening the number of stock options granted in the near future.
They also downplay the impact of an accounting change, because the fair value of most options issued in 2000 and 2001 is likely to be lower than the 1990s bull market given recent drops in share prices.
Soundview's Rohan believes the forward-looking nature of the accounting change could actually benefit to companies that have over-used options in the past.
"Coca-Cola intends to begin expensing options-based compensation expense in the fourth quarter, which implies that it will not attempt to restate its past earnings periods to reflect the value of past option grants on current earnings," he says.
"In other words, if a company were to dramatically reduce the magnitude of its option grants in the future, all past option grants, however excessive, will be forgiven," he adds.
John Filar Atwood is the Managing Editor at CCH Washington Service Bureau.
Companies mentioned in this article
Coca-Cola (KO)
Boeing (BA)
Winn-Dixie (WIN)
CIENA (CIEN)
Finisar (FNSR)
JDS Uniphase (JDSU)
EchoStar (DISH)
Pegasus (PGTV)
Sirius Satellite (SIRI)
XM Satellite (XMSR)
Cisco (CSCO)
Lucent (LU)
Nortel (NT)
Alcatel (ALA)
Nokia (NOK)
Growing pressure to account for options as expenses could further damage industry bottom lines
by John Filar Atwood, equity research columnist
Riddled by massive debt loads, dreadful investor sentiment, and an ongoing slump in demand, telecom execs don't need another headache. But it looks like they might soon get one, and from an unlikely source.
Coca-Cola (KO) announced last week it would begin accounting for stock options as an expense. Analysts say that Coke―joining other S&P 500 players Boeing (BA) and Winn-Dixie (WIN)―has the clout to force other large corporations to follow suit. "Coca-Cola's status as an American business icon will catalyze business leaders to react," says SoundView's Jordan Rohan.
William Kidd of Lehman Brothers agrees. "Others are likely to follow suit, though most corporations are naturally resistant to such a change, thinking that it will eliminate the efficacy of options," he says.
He adds that what currently amounts only to peer pressure may soon become a requirement, because Congress is currently considering legislation that would permanently change the accounting treatment of options.
The bottom-line effects of such an accounting change could be dramatic on the ailing telecom industry, analysts say. Merrill Lynch's Tom Astle says that if the new options accounting were applied to 2001 results, CIENA (CIEN), Finisar (FNSR), and JDS Uniphase (JDSU) would have taken a major hit to pro-forma earnings.
"2001 options earnings for CIEN, FNSR and JDSU would be reduced by 170 percent, 100 percent, and 75 percent, respectively," he says. "Another way to look at it is that option cost alone would be 21 percent, 13 percent, and 17 percent of 2001 revenues, respectively."
Kidd adds that satellite companies also would have been affected. Treating options as an expense in 2001 would have reduced the sector's earnings per share by 14 percent, he noted. He says EchoStar (DISH) appears to have the least exposure to an accounting rule change, while companies with liquidity problems like Pegasus (PGTV), Sirius Satellite (SIRI), and XM Satellite (XMSR) would be more vulnerable.
Lehman analysts Stuart Jeffrey, Tim Luke and Steven Levy report that within the large-cap telecom equipment group, the impact would have been felt the most by Cisco (CSCO), Lucent (LU), and Nortel (NT) in the U.S. and Alcatel (ALA) and Nokia (NOK) in Europe. They recommend that investors monitor the size and frequency of future option grants at each of these firms.
Reports for further inquiry
Telecom equipment: Option accounting impact in communications equipment
Wireless equipment and data networking: Option exp.-assessing potential impact
However, they also caution investors not to over-emphasize the effect of an options accounting change because they believe the impact of stock option expenses will fall going forward.
"Companies will likely have at least 18 months to adjust compensation policy and behavior" to mitigate the impact of the change, they write in a recent report. For example, they believe companies may grant fewer options as part of employee compensation packages, or extend option vesting periods to spread the cost over a greater period.
They note that during the late 1990s, telecom equipment vendors used options as sweeteners in technology acquisitions. Those acquisitions will be far less frequent, in their view, further dampening the number of stock options granted in the near future.
They also downplay the impact of an accounting change, because the fair value of most options issued in 2000 and 2001 is likely to be lower than the 1990s bull market given recent drops in share prices.
Soundview's Rohan believes the forward-looking nature of the accounting change could actually benefit to companies that have over-used options in the past.
"Coca-Cola intends to begin expensing options-based compensation expense in the fourth quarter, which implies that it will not attempt to restate its past earnings periods to reflect the value of past option grants on current earnings," he says.
"In other words, if a company were to dramatically reduce the magnitude of its option grants in the future, all past option grants, however excessive, will be forgiven," he adds.
John Filar Atwood is the Managing Editor at CCH Washington Service Bureau.
Companies mentioned in this article
Coca-Cola (KO)
Boeing (BA)
Winn-Dixie (WIN)
CIENA (CIEN)
Finisar (FNSR)
JDS Uniphase (JDSU)
EchoStar (DISH)
Pegasus (PGTV)
Sirius Satellite (SIRI)
XM Satellite (XMSR)
Cisco (CSCO)
Lucent (LU)
Nortel (NT)
Alcatel (ALA)
Nokia (NOK)
