Stock option expensing
Interview: Blaylock & Partners---Lowy, Gabriel---Analyst
>> the house financial services committee voted to weaken a proposed rule on stock option expensing. cisco, intel and other companies would have to treat options given only to their top five executives as a compensation cost under a bill approved by the committee. the financial accounting standards board is completing a rule that would force companies to deduct the cost of all options from profits. critics say it would depress profit, inhibit hiring and produce inaccurate expense estimates. our next guest says he likes cisco systems as a company but says it’s currently overvalued. gabe lowy is director of technology research at blaylock and partners and joins me from the studio. what do you think about this options expensing issue?
>> i think basically it amounts to a nonissue. because even if the harsher rule would have been imposed on the companies, i think the vast majority in the investment community, particularly among% -the sell-side analysts would% -have taken it out and reported it on a pro forma basis excluding the options expense. i don’t necessarily agree with it, but if you would include the options expense for most companies, it would take earnings down severely, suggesting the markets are way overpriced for this type of expense.
>> the roots of this legislation are in the tech bubble burst and now that seems ancient history and outdated in a way.
>> it does. but a lot of the executives will still use the same excuses, the need to attract and retain talent, options had been the predominant way they’ve done that.
>> but you’ll give options till you’re blue in the face.
>> and the shareholders bear the cost of that. but ultimately i think when they value the companies, those same shareholders who bear the cost of it won’t value the companies on a post-options expense.
>> let’s talk about cisco, if we will, bear stearns having their% -technology conference tomorrow% -and an interview with john chambers. our technology news team―if you were to be sitting with john chambers tomorrow, what would you ask him?
>> i’d ask him to talk about where he thinks the growth opportunities are in the company, specifically some of the advance technology businesses, the storage area, the wireless lan area, security, these are all robust businesses, quite competitive, but also what other product sectors he’s got up his sleeve where they haven’t announced any position yet. are they going to buy their way into it? are they developing some type of technology in house they expect to launch but i presume over the second half of the calendar year we’ll hear more about that.
>> you’ve a hold rating on the stock strictly because of valuation. 32 times estimated earnings for 2004, six times book value, 7.7 times sales and 26% profit margins. are those the valuation metrics% you’re concerned about or am i overlooking operating profit?
>> those are part of the valuation metrics but the thing that drives i.t. valuations or i.t./networking valuations are first and foremost price-to-sales because it’s sales growth everyone pays for and secondly, what does that turn into as an earnings growth rate and therefore price-to-growth rate becomes the second most meaningful metric. we have a model that defines these parameters for all the companies we follow consistently so when we run cisco through the model, we’re interested in buying below $18. we think it’s fairly valued a year from today at about $21 and if it returned over $26 to $26.5, we’d think about lightening up. but cisco we view as a core holding and one which you trade around that core position rather than buy or sell entire positions of it at one time. >> there’s been much talk about the recovery and i’m hearing people in the last week or so saying that corporate spending will improve. we’ve been waiting to hear that, but do you actually see it and hear it from the companies you cover?
>> it is real and i see it throughout the landscape but i would also temper that somewhat. yes, we are coming through a recovery after three horrible years, both on the corporate enterprise markets and particularly the telecom market . but what we’re seeing is a rather muted recovery. and certainly the spending levels that are coming through now and a lot of i.t. managers are indicating for the balance of the year would suggest that% -the spending is not where we would expect it to be at this stage of an economic recovery.
>> a disaster of a day for red hat, the stock down over 20% in five day and it is c.e.o. quits today. your thoughts?
>> it’s why i’m hoarse right now. i think it was overdone. it was an ill-timed announcement. there was no impropriety at the company. the executive was burnt out and the fundamentals are solid.
>> thank you very much for answering all of those questions, gabe lowy. and we’ll be right back.
