Thursday, September 10, 2009

Incentives Gone Awry

Stock options are intended to align the interests of management with those of shareholders. As we've previously discussed, however, they don't always work like that. Nowhere is this more clear than at Acorn (ATV), an infomercial marketer. Acorn trades for $100 million, but holds $140 million in cash.

Shareholders are imploring management to pay that cash out, as last quarter's conference call contained the following statements:

"...[W]hy not consider a special dividend to shareholders and for this reason, when I look at the Shanghai Composite Index, year-to-date, it is up 55%, the Hang Seng China Equity Index is up 46% and your stock is up less than 1% this year...I would highly encourage you to consider a special dividend."

"I'd like to also support the thought of a one-time cash dividend, which would distribute your overcapitalized cash for the benefit of all shareholders without impairing your trading volume. You may recall, I mentioned that in our meeting back in July."

Management assured these shareholders that they will consider these suggestions. But upon closer inspection, it is clear to see why management would be so hesitant to pay out: there are almost 15 million options outstanding, while the company only has 87 million shares outstanding. If a one-time dividend were to be paid, option holders would get nothing, and their claim on the company would be much lower in two respects:

1) It is less likely that the company's share price would exceed a given option's exercise price, thus reducing the number of options that may be exercised and,
2) Each exercised option will also be worth less, since there will be less cash on the balance sheet than otherwise

But while management does own a significant stake in the company, they do not control it. As such, the rumblings of these small shareholders might win out in the end, forcing management to eat options they would prefer to exercise.

Disclosure: Author has a long position in shares of ATV


Anonymous said...

what about a share buyback?

Saj Karsan said...

There is authorization for a share buyback in place, however, due to the illiquidity of the stock, the buybacks were put on hold.

Valeur et Profit said...

You wrote : "Acorn trades for $100 million, but holds $140 million in cash.".

Please read the sec filings...

87 M Shares x 3,87 USD = 337 M USD.

Value investing means doing their home work.

Saj Karsan said...

Hi Valeur,

You are correct about the number of ordinary shares, but I believe you are quoting the price of the ADS (NOT the ordinary shares) in your calculation of market cap.

As per the company's 20-F filing, page 1:

"Our ADSs, each representing three ordinary shares, are listed on the New York Stock Exchange under the symbol “ATV”

Please confirm, thanks! -Saj

Anonymous said...

Mr Karsan,
As a beginning value investor I am a big fan of your blog as it helps me learn how to analyze balance sheets and think about investments. With regard to ATV are you aware of a variant perception that keeps the shares so cheap? To what extent does this generally factor into your investment decision making? Thanks,

Saj Karsan said...

Hi Ben,

Can you explain a bit more what you mean by "variant perception"? Do you mean the market's view of why the current price might be justified?

Anonymous said...

Yes, that's what I meant. Although he evolved into more of a top down investor Michael Steinhardt said in No Bull that he always looks for the competing argument (he called it variant perception) in a trade. Thanks,

Saj Karsan said...

Hi Ben,

I don't put a lot of energy into trying to figure out what the market thinks about a company. Instead, I try to focus on putting an objective and conservative valuation on it myself.

In the case of ATV, the market may be focusing on its abysmal earnings record of the last few quarters. As we've discussed before, the market does tend to focus on very recent earnings, while long-term earnings capacity and the company's financial position (balance sheet) are not given the importance they should be.

Hope that helps!