The Wired Investor: An SEC Clampdown Is Shaking Up the Valley
Fortune March 15, 1999
What's Behind Tech Stock Prices?
Adam Lashinsky
As if there weren't enough reasons for
tech-stock volatility, add one more: a
crackdown by the SEC on the way technology
companies account for mergers and acquisitions.
Accounting rules as a major market force may
sound like a stretch, but the spat that's going
on between Washington and Silicon Valley is in
fact sowing fear and uncertainty among
investors, and the potential ramifications for
stock prices are huge.
The targeting of mergers is part of a larger jihad
by the SEC against what it considers to be
misleading accounting, including "earnings
management" and other techniques by which
corporations allegedly obscure true value. Lynn
E. Turner, the SEC's chief accountant--and a
former semiconductor CFO--has singled out
technology concerns' write-offs of so-called
in-process research and development,
challenging the accounting at more than 150
companies--including America Online, Excite,
Motorola, and Cabletron.
Why tech companies? For one thing, they're big
on R&D. They're also keen on paying large
amounts for unproven concerns that may harbor
in their labs the Next Big Thing. When a
company is acquired for more than book
value--or hard assets, typically meager at tech
startups--the difference must be recorded as
goodwill, which is written off over several years.
A loophole allows buyers to write down
immediately a portion of an acquired company
whose technology is under development, or "in
process." Big up-front charge-offs may depress
earnings today, but they lead to lower expenses
and higher earnings later. And investors in
high-tech companies, unlike typical investors,
are far more interested in future profits than
current earnings (or the lack thereof).
Sensing a good deal, Silicon Valley companies
began taking larger write-offs. Some even
expensed 100% of the value of their
acquisitions--until Turner pointed out that
acquisitions must carry costs.
As Turner floods the Valley with warning letters,
analysts are unsure whether to knock down
valuations over what is essentially a noncash
accounting matter. "I told the SEC, 'You guys
are destroying investors' confidence in reported
earnings,'" says Goldman Sachs analyst Richard
G. Sherlund. The Software and Information
Industry Association has even threatened to sue
the SEC.
Some companies have simply converted to the
new norms without waiting for the SEC to come
knocking. RealNetworks, a Seattle-based maker
of software used for Internet broadcasting,
announced in late January that it will voluntarily
reverse $9.2 million in R&D charges from a
year-old acquisition. The market's reaction?
Shares kept rising.
"It was pretty clear the landscape was
changing," says RealNetworks CFO Paul Bialek.
"We have very solid momentum, and the
restatement won't change the economics of the
[acquisition] at all." (Of course, since
RealNetworks is unprofitable to begin with,
investors obviously were already comfortable
with red ink.)
Companies that wait for the SEC to pounce may
suffer more. Amid rumors that the SEC was
poking around, Network Associates, a Santa
Clara, Calif., provider of network-security
software, saw its stock yo-yo for six months,
finally falling 12% in late December. On Jan. 6 it
finally disclosed that the SEC could require a
restatement of as much as $220 million in
charges for past acquisitions. The stock dropped
a further 19%, to $45.19, until Jan. 21, when
CEO William L. Larson called a teleconference to
pooh-pooh the impact of the SEC probe and
announce that his company would nevertheless
report two sets of earnings--the SEC's way and
the Valley's way. Shares shot up to nearly $55
within a week.
Eventually--perhaps in six to 18 months--new
standards will be finalized. Until then, deciding
what tech stocks are really worth will be
tougher than ever.
Adam Lashinsky is a columnist for the San Jose
Mercury News. You can read his column at
http://www.sjmercury.com/columnists/lashinsky/
and e-mail him at alashinsky@sjmercury.com.
Issue date: March 15, 1999
Vol. 139, No. 5