ESOP’s Fables: MWG turns fantasy into reality

Recent news from Mobile World Group (MWG VN) that it plans a 2016 executive/employee/partner share award program amounting to a 3-5% stake in the company, on top of the 5% 2015 one, brings to mind the risks to shareholder value of poorly structured stock awards to insiders. Incentivising management and employees with stock is an excellent concept for minority outside shareholders, but the devil lies in the precise method employed and in the size of the award relative to that of the overall company.
In MWG’s case, a potential award of 10% of the company over two years at an exercise price of nil fails on both the above counts. A 5% gratis award per annum for a stock trading on a 13x prospective multiple (or earnings yield of 7.7%) is a giveaway in value of about two-thirds (5/7.7) of the annual profits that the company is making – and now this is happening twice, not just once. So MWG is doing great as a company, but the poor outside shareholder is seeing her lunch (profits) mostly eaten up by the insiders.

Big giveaways of free stock are a common feature of early-stage, high-growth Silicon Valley businesses, but it is dubious that MWG is in quite this same category: granted, it has an impressive CEO with entrepreneurial vision in a high-growth economy, but its main business is the relatively mundane one of mobile phone retailing.

A few might protest that share awards do not subtract from profit. In a sense they are correct: dividing profit by 5% more shares is hardly a cataclysm for investors in a high-growth company. But good schoolboys also remember Warren Buffett’s faultless logic: “If share awards are not compensation, what are they? And if compensation is not a cost for accounting purposes, what is it?” So if MWG were to make a habit of awards of this size, it would be reasonable to discount the long term value to the outside shareholder of its business model.

Here is MM’s small list of share award methods he has seen, with the last one representing the only truly proper way to award stock to insiders:-

> 1) ESOP with exercise at very low or par value (or for free). This is almost straight theft, although if relatively small in size, most outside investors overlook it. The recipient gets an instant windfall and therefore the incentivisation impact is blunted. All the worse if the award is of major size relative to total outstanding share capital.

> 2) ESOP with a higher price, close to or exceeding current share price. Far better at incentivising than (1), but the problem becomes one of top management becoming excessively interested in gaming the share price up in the short term, in order to make a quick fortune, at the expense of long term shareholder interests (eg Enron).

> 3) ESOP with high price and with long vesting periods, or grants of restricted stock (making up the majority of an individual’s compensation) vesting only progressively after several years. This is like (2) but with measures to deter short-termism by management. It is the only truly fair and proper way to make stock awards from the perspective of rigorous shareholder value.

Mekong Man

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