A new study just published by investment banker Merrill Lynch has highlighted some interesting cross border disparities between high tech companies in the US and their overseas competitors. Written by Merrill’s accounting expert and CPA, Gary Schieneman, the report also delves deeper into two controversial areas of US accounting, namely purchased R&D write-offs and share options, showing how the reported earnings in the US would suffer if current accounting rules were tightened up. Schieneman’s study covers 32 companies within the technology sector, including software, hardware, semiconductors, telecommunications and consumer electronics. 17 of these companies are based in the US while 15 of them are non-US. Underpinning the need for this report was the fact that as a group, the companies studied derived 48% of their revenues from outside of their home markets. This, said Schieneman, made the technology sector the most global industry so far studied by Merrill Lynch.
By Alex Sloley
The report’s conclusion is that US companies are nearly twice as profitable as their non-US competitors. Consequently, the stock prices of the US companies are relatively higher when measured by a whole range of valuation criteria, including the classic price/earnings and price/growth ratios. And most expensive of all, relative to its earnings and growth, are shares in Microsoft Corp. The biggest non-US software company, SAP AG, came in fifth on the share expense scale. Schieneman then proceeds to dip into the murky world of employee share options, a method of rewarding employees which is now so heavily used by US companies that observers are questioning the potential dilution of earnings, and also the masking effect options have on underlying profitability. On a scale of who has the most options pending, top once again is Microsoft, which has 20% of its outstanding share capital subject to employee stock options. Close behind is Dell Computer Corp with 17% followed by Apple Computer Corp, Sun Microsystems Inc and Cisco Systems Inc, all with around 14%. US companies currently show no expenses relating to the grant of these options in their profit and loss accounts. This is significant because stock options now form a huge chunk of their employees’ remuneration. Schieneman estimates that if the US companies in his study chose to use new accounting rules, issued by the FASB in 1995 as a fair value alternative, then reported earnings would decrease by an average of 12% across the group. Back to the lists again, and this time Lucent Technologies Inc is top with a huge 32% reduction in earnings if fair value accounting were to be adopted. Second is Cisco with a 25% reduction and third is National Semiconductor Inc, on 22%. Microsoft comes in fifth with a 15% reduction. Schieneman points out that stock options are a predominantly US phenomenon, giving US companies a huge lift in reported profitability.
R&D write-offs
The report then moves on to the use of in process R&D write-offs in acquisition accounting. This is an even more controversial area because the US Securities and Exchange Commission has recently taken aggressive action to combat the excessive use of this technique. In doing so, the SEC has deliberately targeted the technology sector. Schieneman estimates that if this accounting method is removed from play, certain acquisitive companies covered by his study would see their earnings suffer. National Semiconductor Corp’s earnings would fall 10%, for example, while Texas Instruments Inc’s would drop by 9%. Summing up, the report says that earnings growth across the study group for the past five years (1993-1997) has been running at a break neck speed of 40%. This, estimates Merrill Lynch, cannot be sustained. Analyst’s forecasts for the group for 1997-1999 predict earnings growth of just 14%, although this rises to 20% if the depressed semiconductor companies are removed from the equation. Schieneman’s colleague at Merrill Lynch, technology analyst Steven Milunovich, says the sector is rapidly maturing which leads to two conclusions. Firstly, we’ll see a host of newer company’s emerging to challenge the old order. And secondly, investors buying into technology stocks on the back of current, super high valuations had better watch out. á
