Bridgepoint: Why Convertible Shares Don't Appear on Income Statements

Jun.23.09 | About: Bridgepoint Education, (BPI)

A few readers alerted me on one of the newest Magic Formula stocks, Bridgepoint Education (NYSE:BPI), as to a possible problem with the official screen listing this as an MFI stock. On that screen, BPI is listed as having an enterprise value of about $69 million, but most of the large financial sites such as Yahoo!, Google, and Morningstar have the market capitalization at a much higher $860 million, with enterprise value only slightly lower at $811 million. That's a pretty large difference, so MagicDiligence wanted to sort out what was going on here.

As it turns out, something that seemed trivial turned out to be more complex than expected! The root of the problem is easy enough to understand. The main financial sites were using an outstanding share count of about 55 million, while the MFI screen was using the value given by the company in their last 10-Q of 8.1 million shares. What is confusing, though, is that Bridgepoint's 10-Q lists $3.3 million of net income, but only 0.03 of per-share earnings. Clearly, something does not compute, as $3.3 million divided by 8.1 million shares should come out as about 0.41 of per share earnings. Time to dig into the notes.

Looking farther down, we find a "note" on how earnings per share is calculated. Sure enough, we see that Bridgepoint has over 60 million preferred convertible shares outstanding, as well as another 205 thousand outstanding purchase warrants. All told, there are about 64 million share claims on net income - above even what Yahoo! reports, and the "right" answer when calculating market capitalization and enterprise value.

The bottom line is this: the official Magic Formula screen's calculation of Bridgepoint Education's enterprise value is wrong, and the stock should *not* be on the screen. The correct market cap is about $1.07 billion, and the correct enterprise value about $995 million. With these values, earnings yield is about 4.8%, way too low to be a Magic Formula stock.

It's interesting, and instructive, to learn a little more about why Bridgepoint does not have to put the 60 million in convertible shares into its income statement. These shares are convertible at a higher price than the common shares, meaning that, if converted, they would add more to net income than would be diluted by the higher common share count (known as "anti-dilutive"). The same goes for the purchase warrants. Therefore, by accounting rules, these shares do not have to be accounted for in this reporting period.

Of course, a higher share count would not only affect the current quarter, but all subsequent ones. The higher net income would be a one-time gain. That's why we need to consider what the full dilution potential is.

IPOs often cause these kind of research headaches and need to be looked at carefully before diving in. I recommend MFI investors to scratch Bridgepoint Education off the list before choosing stocks.

Disclosure: Steve owns no position in any stocks discussed in this article.