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APRIL 30, 2003
By Alex Salkever eBay's Scary Stock-Option Specter First, consider the $127 million "error" in its earlier reports. Then consider what its earnings would be if it has to expense options
The stock's gravity-defying ride -- eBay is up 82.5% over the past 52 weeks -- has divided the investment community into two camps. One one side are the true believers, chief among them many mutual-fund managers, who think eBay easily will prove deserving of its lofty valuation as one of the last true growth stocks around. On the other is a smaller but vocal group that says eBay's valuation harks back to bubblenomics -- something that, at some point, must come down to earth. FASCINATING FOOTNOTE. King among the eBay bears is Albert Meyer, the brains behind independent stock-analysis firm Second Opinion Research. Meyer calls eBay "one of the most expensive stocks on the planet." According to First Call Thomson Financial, it has a trailing price-to-earnings ratio of 93. That actually lags behind some other Net bellwethers, such as Internet portal Yahoo! (YHOO ), which has a trailing p-e of 105. But the p-e alone may not reflect how pricey eBay is because it and many of its peers aren't necessarily profitable yet year in and year out, says Meyer. His biggest concern these days: a footnote buried in eBay's 2002 annual statement relating to how it treats stock-option grants for accounting purposes. In eBay's audited 2001 return, it listed the pro forma cost of such grants for 2000 and 2001 at $244 million. Yet in its 2002 results, eBay listed the number for that same period at $371 million -- a $127 million discrepancy. "Doesn't this amount to an actual restatement?" asks Meyer, who believes eBay should have made more prominent notice of this change and who also wonders how auditors could have missed such a big shift. Absolutely not, responds eBay. A spokesperson says the changed number is nothing more than a "clerical error on eBay's part," one that it has acknowledged in its 10K report to the Securities & Exchange Commission. The spokesperson says the error didn't require any changes to the income statement, balance sheet, or cash-flow statement. DIFFERENT STANDARDS. Still, Meyer raises an interesting point. Stock-option grants can be a key part of a company's financial obligations. Their value ultimately costs investors, since those shares are often issued in lieu of wages and represent real value being handed over to employees. And with regulators pondering new rules requiring all companies -- Old Economy and New Economy -- to expense their options, eBay's options accounting could receive more interest, particularly going forward. eBay is right that it isn't required to restate its earnings to reflect this change in options costs, according to Penn State University accounting professor Ed Ketz, an expert on accounting scandals and the author of the soon-to-be published Hidden Financial Risk. That's because the numbers were pro forma -- that is, based on hypothetical stock prices. Tech outfits and growth companies have long handed out options rather than fatter paychecks. Initially, the reasons were twofold: Stock options were a way to reward management in tech companies without using revenues that could be plowed back into building the business. Also, lots of high-tech startups believed in giving a larger group of employees a stake in the company's future. The widespread use of options as compensation during the dot-com craze is precisely why the Financial Accounting Standards Board (FASB) is now contemplating rule changes that would require all companies to list the cost of stock-option grants as an operating expense, and not as a separate footnote with no impact on reported earnings. Some Old Economy companies want it that way: They have long routinely expensed executive pay packages -- taking a hit against the bottom line -- while most New Economy highfliers blithely handed out huge, potentially valuable options to managers without having to deduct the value against earnings.
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