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The Starting Line: Juniper's options exchange draws fire

Analysts pan the company's plan to let employees trade in underwater stock options and may make other tech companies think twice about similar swaps.

Compensation experts may want to heed the message sent by Juniper Networks shareholders: Six and one don't add up to stock price gains.

Shares of Juniper fell more than 11 percent Tuesday after the maker of high-speed routers set plans to become the latest company to give employees the choice of new stock options. Morgan Stanley analyst Christopher Stix expressed the belief of many on Wall Street: "These types of exchanges misalign employee and investor interests...Employees have no incentive to see stock go up."

Following the model set in recent years by the likes of Amazon.com and Sprint, Juniper is giving employees the chance to exchange current options for a set of new ones six months and a day from the date that a tender offer ends. Although the company hasn't formally set a schedule, a filing this week with the Securities and Exchange Commission includes a hypothetical timetable that would result in the new options being granted in May of next year.

Due to more favorable accounting, stock option exchange programs have become more popular than traditional repricing, in which a company just doles out new options with lower strike prices. In previous years, shareholder advocates have found stock option repricings irksome.

Companies that carry out these so-called six-and-one options trades won't call them "repricing," because the Financial Accounting Standards Board (FASB) has decreed that options repricings must be recorded as charges to earnings. But the effect is essentially the same, albeit delayed by half a year: Employee options have a lower strike price.

Proponents defend the practice as a good way to keep employees in the face of a bear market. Juniper has lost 95 percent of its value since October 2000, although the company has done an admirable job of minimizing its earnings decline compared to other network equipment vendors.

Tech, Internet and communications companies--the sectors leading the late '90s bull market and its related frenzy of options--have been particularly ardent practitioners lately. Amazon.com and Sprint were among the first companies to announce six-and-ones last year; this year the group has included Broadcom, Ariba and WebMethods.

Wall Street hasn't been worried until now. Ariba, Broadcom and WebMethods saw their stock values increase immediately after unveiling options exchanges. Even after accounting for the fact that the overall stock market was rising in April when those companies released their six-and-one plans, the lack of any negative reaction stands as a marked contrast to the Street's mood about options compensation these days. The backlash to Juniper's options exchange could deter other tech companies from offering similar swaps.

Juniper's tumble on Tuesday certainly wasn't attributable to any sectorwide trends. The company's chief rival, Cisco Systems, rose slightly, as did the Nasdaq composite index and the CNET Networking Index.

Filing spurs rebuke
However, Juniper's SEC filing spurred at least three analysts to rebuke the company for giving employees the chance to benefit from a lower stock price. Morgan Stanley's Stix, Merrill Lynch's Samuel Wilson and Needham's Tad LaFountain had nothing but criticism for the idea. LaFountain kept a "strong buy" rating on Juniper, but cut his price target to $31; the stock no longer deserves to be valued at a premium to its estimated growth rate, he said.

"I will be taking the same approach with any company I cover that reprices options," LaFountain wrote. "This move is an affront to public shareholders who have incurred actual losses. The public gets no chance to reprice its cost basis. While we are not unsympathetic to the lost potential gains of the employees, we believe that it pales in comparison to the actual losses suffered by a group that has no recourse to financial convenience."

LaFountain argues that repricing options isn't needed because employees are less likely to leave nowadays, given the general collapse of the networking and technology sectors. Employees who truly care about building a long-lasting company won't be so quick to jump ship anyway, LaFountain said.

Six-and-one critics are quick to note that by forcing employees to wait six months and a day before new options are granted, employees actually have a reason to drive the stock price lower in the short term, to get a better strike price.

"While there is no doubt that the long-term interests of employees and enterprises are closely intertwined, there are periods when there can be substantial divergence," LaFountain said. "This is one case where the interests of the enterprise and its shareholders should take precedence over the perceived financial interests of the employees."

Companies always have to worry about losing good employees no matter what the economic situation is, said Bill Coleman, Salary.com's senior vice president for compensation. "Juniper's best employees are still of value to other companies," he said, adding that even mediocre employees are expensive to replace.

And without an options exchange or some other form of repricing, employees may take matters into their own hands by going to another company, and thus getting new options with a strike price that matches the current market anyway. "They effectively reprice their options by changing jobs," Coleman said.

Nonetheless, investors should be concerned about six-and-one exchanges, he said. Shareholders have a right to ask why they have to suffer with a lower price while employees get an alternative, Coleman said.

Juniper can't control the market, but it can keep its business healthy by keeping good employees, said Adam Stein, the company's director of corporate marketing.

"It's not for us to say what the market should be today and tomorrow," he said. "Do we know this is the right time to do this (options exchange)? No, we don't. But we're making sure we're protecting our biggest intellectual property, the engineers, the people out in the field, the sales folks."

Investors and analysts generally don't mind options exchanges as long as companies are conservative about them, Coleman said. Many organizations go with "value" options exchanges, under which employees get fewer options than they had before, in return for a new strike price. And many companies exclude senior executives from six-and-one plans.

"If the plan or approach is reasonable and not excessive or greedy...then they (shareholders and employees) are not diametrically opposed," Coleman said. "It's still to everyone's benefit for the stock price to go up."

Juniper's proposal calls for a one-to-one options exchange. Company executives are eligible for the options exchange, which probably irritated more than a few investors.

"Letting executives take part would be a huge red flag," Coleman said. "That will send shareholders and analysts into a fit every time."

Opponents' biggest problem with options exchanges and repricings in general might simply be a question of risk and reward. Employees and executives who were so willing to cash in when the market was peaking ought to be willing to take the pain when stocks are crashing.

"I doubt anyone can recall a time when companies repriced options because the stock price was rising too fast," said Coleman.

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