The year 2000 was a very good one for Forest Laboratories. Amid a backdrop of plummeting indices, shares in the New York-based drug company were up over 100 percent, ending the year in the high $60s. And then the general malaise afflicting the great majority of stocks caught up with Forest.
‘We were hit hard in the first weeks of the new year. We quickly dropped from the high $60s to the mid $50s,’ says Charles Triano, Forest’s vice president of investor relations.
Of course, for some companies, lackluster valuations are a reflection of deteriorating company fundamentals. Think of Lucent, which seems bent on trying to commit corporate suicide by missing its numbers repeatedly, courting SEC regulatory probes, and doing nearly everything else in its powers to frustrate shareholders. But for Forest Laboratories and many otherwise financially solid enterprises, the problem is largely a function of external forces. (Triano notes his company’s downturn coincided with an investor rotation out of the drug sector and other high P/E stocks.)
The result is a sagging share price and a shareholder base hungry for a return to upward mobility in an era of investing when patience is measured in days. And while companies have been increasingly relying on options to lure employees, many of those options have slumped in value. Call it a new stakeholder formula, one that has prompted various responses from firms trying to lift their battered share prices and inspire investors, outside and inside the organization, to stay patient.
Option problem
According to one recent estimate, nearly half of all options in the US may be ‘out of the money’, or priced above the value of the stock. That leaves the companies that relied on them heavily in a difficult bind. ‘I’d say my role has been expanded to include more encouraging other employees who feel despair at the stock price,’ says Janice Simoncelli, IR manager for e-commerce site Outpost.com, a company with a stock price just below $2, down from $11 in March.
This environment is forcing a few high-tech companies to consider the nearly unthinkable – repricing options. For starters, repricing options for employees is the sort of move that causes otherwise sedate investors to start hurling tomatoes during shareholder meetings. And in the US, repricing is even more complicated since a new FASB accounting rule that requires companies repricing options to take charges that reflect potential stock market gains when their shares rise.
As an alternative, some companies issue new options at lower prices. ‘We had a very bad second half of 2000 like most internet or tech companies. For our employees, we gave out additional options out of our existing stock options plan,’ explains Stefan Zenker, IR manager of Fluxx.com, a German online gaming company.
But issuing new options has its risks, particularly the dilutive effect, something investors are increasingly concerned about. As for restricted stock – that can’t be sold before a certain date – the shares are considered compensation and so reduce earnings, unlike options. And generally speaking, restricted shares are primarily used with senior executives, because the shares can’t be sold for one year under US SEC rules.
A more favorable route in the US, especially for companies that don’t have the luxury of doling out more cash – and given the earnings shortfalls being reported, that’s quite a few – is canceling the options, waiting six months plus one day, and then issuing new ones, thereby avoiding having to record the move as an expense.
‘If you’re about to collapse, you may as well reprice. But if you’re not about to immediately collapse, then canceling, waiting and finally issuing new options is a better route,’ says James Reda, a principal and compensation specialist at Buck Consultants in Atlanta.
One firm that canceled and then replaced is Sprint PCS, which suffered a blow after its merger with WorldCom was called off in 2000, sending shares lower due to the removal of its merger premium. ‘We canceled the option grants for 2000, and we’re going to replace them in May 2001. These options were underwater, making them worthless as a retention tool,’ says Kurt Fawkes, head of IR at Sprint PCS.
Fawkes says investors understood the need to act quickly to retain staff. And he says that because employees’ replacement options will be priced according to the then current market value, meaning they risk missing an upswing during the holding period, they’re not getting ‘something for nothing,’ which makes it more palatable to investors.
Refusing to touch options
The distaste investors have for tinkering with options is surmountable, but many companies, including dot-coms, are refusing to reprice or even cancel. ‘We are not going to reprice stock options and we have no plans and have never considered it. All our employees are granted stock options after being hired so everyone has a stake. If we reprice, we would be treating our employees differently than other shareholders who are suffering just as we are,’ says Simoncelli.
In Europe, where accounting repercussions from repricing aren’t a factor, most firms are wary of the fury repricing can inspire. ‘We don’t consider repricing. We believe you should stick to the original options, especially because repricing is not at all in line with shareholders’ views on the subject,’ says Gundolf Moritz, VP of IR at Germany’s SAP.
To soothe some of the frayed nerves among employee shareholders, both Moritz and Simoncelli say they’re busy keeping communications with both shareholders and employees as open as possible. At the same time, they underscore the strengths of their businesses. ‘We’re making all the right moves – increasing product margins, spending less on ads, controlling costs, increasing revenue,’ says Simoncelli.
As for the message, she makes sure it reaches employees as well as other investors, going so far as to allow them, along with virtually anyone else, to participate in the company’s quarterly conference calls. ‘Quite honestly, we share our information with everyone. It’s an open conference call, including employees. And we get great questions from everyone, including employees.’
At SAP, the company has set up an intranet to deal with an increasing appetite among employees for financial information on the company. ‘Since we’re a global company, employees are attuned to the stock price, unlike at other European companies. This is especially true of our US employees. We get a lot of requests, but we have a very effective team for internal IR. We have lots of information on our intranet IR site, such as updating employees on updated broker reports, which is something we don’t put on the external site.’
The buy-back plan
Regardless of the strategy companies employ to appease employees, those that aren’t about to implode due to staff departures have to deal with the rest of the shareholder base. One approach is stock buy-backs, which are intended to highlight a firm’s confidence in its future, reduce dilution – including that caused by option plans – and lift stock prices.
With stock prices so low, many investors see this as a good use of capital, and a way to give the stock a shot in the arm. ‘We’re finding that the biggest question from investors is, Why aren’t we buying back our stock given the current price? But in the internet sector, we all have burn rate issues, so we’re trying to conserve capital and a buy-back is not an option ,’ laments one dot-com CFO.
Other companies, however, have been quick to announce buy-back plans. In January, media-internet behemoth AOL Time Warner said it planned to repurchase $5 bn worth of its shares over the next two years to reflect the company’s ‘belief in the underlying value of the company and its potential business opportunities moving forward.’
Increasingly, however, investors are wary of such announcements, especially since some firms have failed to execute the repurchases. As for the impact on a company’s stock price, the ‘pop’ shares are supposed to receive is largely a thing of the past.
‘Most of us prefer to buy back shares to offset the dilutive effect of options. That’s what we’ve done. But I don’t think any company has an opportunity to buy back enough shares to meaningfully change their share price. It can be a morale booster; like stock splits, there’s a sort of mythos that they boost the stock. But if you really break it down, splits and buy-backs don’t have a lasting effect,’ says Jim Foltz, director of financial relations at National Semiconductor.
Remember me?
Foltz does advocate making investors aware of what a company is doing right. ‘I’d suggest, whether the market is up or down, you get your story out. Don’t go into hiding. But we can’t hype or cheerlead the story. That’s the common problem with some managements. Our role is to make sure all the appropriate information is out there so investors can make an informed decision.’
Fluxx.com’s Zenker says he’s executing a similar strategy of keeping his company’s name under investors’ noses, hoping for the day when interest in internet stocks takes off. He’s stepped up investor meetings using any chance he gets. He’s also using e-mails and press releases to keep his audience informed. ‘The electronic format is very effective. Maybe there’s a folder containing Fluxx press releases on someone’s PC desktop, and maybe they’re looking for a stock to buy and they open it up.’
While internet stocks have yet to stage a significant rebound or draw back the level of investor interest they enjoyed in the late 1990s, other industries are already seeing renewed interest. Companies maintaining a presence with analysts and potential investors are benefiting.
‘Given Forest’s stock performance last year, many investors have clearly been realizing investment gains, while those who felt they missed the boat have been using market-driven share price declines as a time to buy,’ says Triano. ‘Thus the importance of keeping on hand a good crowd of investors with whom you’ve built relationships – those who are comfortable stepping in at current prices or who may be valuation sensitive and are waiting for the price hiccup to initiate or add to positions.’
For Triano, 2001 is quickly improving. By February, shares of Forest Laboratories were flirting with the low $70s, boosted in part by a bullish analyst report in January. The gist of that report: Forest Laboratories’ fundamentals are intact; its shares have been oversold relative to the industry; and the firm has been raised to a ‘buy’.
The report and ensuing investor interest, says Triano, were a function of the company staying out in front of the investment community during the downturn. ‘As long as you’re out there, you don’t get as many calls after a period of share price weakness asking to be educated – they’re already buying.’
Sober perspective
Robert Kugel, an analyst with First Albany Corporation, is circumspect about strategies companies can employ during down cycles. On the issue of repricing options, he says institutional investors are vehemently opposed. ‘The typical portfolio manager who has to take his lumps when a stock goes down doesn’t have much sympathy. Under almost any circumstance, they’re not thrilled with repricing.’
While companies and employees had previously looked on options as a sure thing, many professional investors viewed ‘the sure thing’ as a temporary measure. ‘It always seemed that the people who would be hurt would not be shareholders, but those who took options instead of hard cash. If you’re going to give people options in lieu of payment in cash, you have to decide if it’s really the best thing for the company over the long term.’
As for a buy-back, Kugel says it might be the right solution for a larger company ignored by the Street but generating significant amounts of cash. ‘It can be a way to enhance shareholder value over the long term. But if you think you’re going to fool the Street by announcing and then quietly not executing the buy-back, there’s decreasing evidence that you can get away with it.’
For small companies, the buy-back option may be a loser. While it may shrink the shares outstanding and give earnings per share an immediate boost, it also reduces the market float, which means some institutions will be discouraged for liquidity reasons.
Kugel’s outlook for some of the newer tech companies, especially the software companies he follows, is especially blunt: ‘There isn’t much of a solution to the predicament of micro-cap software companies, and they remain beached as public companies. In some cases, the best thing to do is to go private rather than paying out dividends or investing in things that aren’t a good fit for your business.’
