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F5 Networks and Options Shenanigans


Unraveling the option grants is not likely to impact the viability or prospects of a company's business.


A jaded take on the rigged-options games.

By the only relevant metric – price – F5 Networks (FFIV) has been misbehaving lately, and that's probably an understatement. The latest whack came on the news that the SEC and the US Attorney's Office is "looking" into how options were doled out to executives.

Let me first give you my opinion on this broader options issue, with all the appropriate caveats: from the standpoint of the companies' operations and their businesses I view this as a non-issue. My guess is that so many companies are involved in this "headline scandal" because some genius accountant / lawyer devised a theory that passed the "laugh test" to justify these bogus awards, and the template then spread to the various "not-so-independent compensation committees." Given the opportunity to potentially pocket some more money vs. embarrassing themselves publicly, the vast majority of executives made the only choice their greedy psyche could grasp, i.e. they pocketed the money.

Was this dishonest? Yes. Criminal? Possibly. Am I concerned about having dishonest people leading companies I have money in? Yes. But as you know from most of my writings, I am also worried that the Fed has brought us to the brink of financial Armageddon, and yet I still have long positions.

My – perhaps cavalier and probably minority – view on all this is that it is no great shocker. If these option grants get unraveled it may lead to restatements of GAAP earnings (when was the last time anyone traded on that?) because the higher strike prices result in higher compensation expenses; there may also be tax deficiencies for not paying taxes on the higher compensation. On the other hand one would presume that taxable income will also be reduced and fully diluted share counts will be revised lower. This is not a scheme to hide losses of failing businesses or to invent non-existent cash flow, and it's tough to imagine a scenario where these option problems alone could sink a company.

I also don't buy into the slippery slope argument that if this CEO did "this" then he can certainly do something worse. I may be jaded, and I may be wrong, but it just does not worry me that much. I have seen worse "greed" in commercial real estate transactions/lending, all masked under the heading of "fees."

My guess is that the options scandal will pad a bunch of lawyers' bottom lines, may cost several people their jobs, and might even send a few for a vacation to the "big house", but from the standpoint of the viability and prospects of a company's business, I put the news-flow in the "if it bleeds it leads" category of journalism.

So back to FFIV. Over the last couple of quarters FFIV achieved cult-stock status and started trading out of its league. The financial impact of competition from Citrix Systems (CTXS) blindsided a lot of itchy trigger mo-mo types, who probably did not even know CTXS existed until the last quarter. Throw in the option headlines, and a market re-acquainting itself with "risk" (at least for a couple of weeks) and what you are left with is a 40% beating.

The way I am approaching this stock is as follows: I like FFIV because it basically does for the core of the network what Akamai (AKAM) does for the edge of the network. If the macro picture for AKAM looks good (and it actually looks great), it must necessarily look good for FFIV as well. What am I willing to pay to be involved? With $11/share in net cash on the balance sheet, EPS growth of 20-25% for the next couple of years (macro things remaining equal), and free cash flow 20% higher than that, a PEG ratio of 1 is not insane.

I did my last round of buying yesterday, I am selling calls against some of my stock today, and I'll probably trade this one back and forth dozens of times. The advantage of a stock like this is that one can use trading to reduce the cost of the core position. Should FFIV's role in the network's food-chain slip, that will be the time that I'll have to worry.

Position in FFIV, AKAM
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