Understated Options Expense at Google Could Create Real Problems

FASB and the SEC require companies to determine the "Fair Values" of ESOs at grant day and expense those "Fair Values" over the vesting period.

For example, the theoretical value of some options may be $1000 on grant day. Perhaps 25% (or $250.00) could be expensed after one year and over each of the next three years.

As far as the FASB expenses against earnings are concerned, it doesn't matter what the stock does after the grant day. If the stock drops and the options have little value, the expense is the same as if the stock had tripled.

This certainly is not the value in the eyes of the grantee. And it certainly is not the real costs of the options to the company.

With the above in mind, let's take a close look at Google's (GOOG) options.

If Google accounted just for the Intrinsic Value of the Options Exercised in 2005 and 2006 as an expense (as that is exactly what the exercising employees reported as compensation income), the two year earnings would be reduced by $3 billion, making the total earnings for the two years $1.4 billion instead of $4.4 Billion.

If the intrinsic value of the vested options not exercised is added to Google expenses, they would show a additional expense of $1.5 -2 billion for 2005and 2006.

Of course there are perhaps another billion of "time premium" that Google is liable for, further raising their potential costs.

Not a pretty picture, no matter how you look at it. All of Google earnings will go to their employees and executives as gains for holding their employee and executive stock options.

Sell it or short it. Buy some puts now when the implied volatility is low. I see no way out. There has been massive selling by insiders in 2006 and 2007. The only question is when will they "pull it".

Disclosure: none

Comments

[borisb:]

makes sense. so your saying that the earnings and cash flow from operations arent clean cut? the intrinsic earnings power is grossly overstated?

2007 May 16 02:44 PM