Taking Stock Revisited / What Kind of Company Does Amnon Landan Run?

This column was originally published on March 21, 2004

Read that headline. It's a dead easy question.

It's not only readers of the Israeli business pages who know which company he runs. So do Forbes readers, since he won the coveted title of the magazine's Entrepreneur of the Year for 2003.

For the last 15 years, Amnon Landan has managed Mercury Interactive, which was founded in 1989 by one Aryeh Finegold. Landan led the company from $20 million sales in 1994 to half a billion dollars in 2003. En route, he also helped lift its market value to $3.8 billion.

Amnon Landan manages a company that has made him one of Israel's richest people, with personal wealth of a quarter of a billion dollars. Amnon Landan runs a company that has made many of its employees millionaires, and that has become an idol in Israel's software sphere.

Mercury is one of Israel's "five wonders," five companies responsible for the strong brand Israeli high-tech has on Wall Street and in Silicon Valley. These companies are industry leaders that not only employ thousands, but that have also created billions of dollars in value for shareholders.

The five wonders

These five wonders - Teva, Check Point, Amdocs, Comverse and Mercury - have netted hundreds of millions of dollars over the years. They did not collapse when the bubble burst, and their balance sheets show equity that isn't based on massive fund raising, but rather on genuine profits.

Two months ago, Mercury published its financial statement for 2003, stating that it netted $41.5 million. Analysts lined up to praise the company and Landan marked up another great year.

So why ask who he is? Everybody knows, don't they? Landan manages a profitable software company that creates value for shareholders, managers, employees, and for the State of Israel, in the form of taxes, not to mention the good PR.

Well, a few days ago Mercury's full financial statement, its 10-K, landed on our desk. It's a document filed with the SEC a few weeks after the short version. The press doesn't normally relate much importance to 10-Ks; journalists and analysts tend to look at sales and profits, not esoterica.

The one question

We found what we were looking for in the notes to the financial statement. Namely, the amended profit and loss statement, presenting the company's results if it had booked the options it gives its people as an expense.

We found that Mercury, which netted $41.5 million for 2003, would have lost $94 million if it had expensed stock options to workers.

Which brings us back to our headline question. What company is Landan running there? The one presenting a $41.5 million profit to the press, or the one that presents a $94 million loss in its notes? What company is Landan running? One that's profitable, or not?

Should options be expensed? Mercury's board of directors doesn't think so. It believes that since the options were granted to workers at the share's market price on the relevant date, they are not a true expense.

But Mercury's directors and managers may gradually become a minority. Almost all the finance mavens on Wall Street think employee stock options are an expense, even if they do not affect cash flow.

Without getting into that question itself, we will note that the moment a company issues options, it is increasing its outstanding shares capital and diluting its profit per share. The workers exercise the options only when their price is below the share price on the market. Ergo, the company is selling shares at less than their market value.

To quote that greatest investor of all, Warren Buffett, on options accounting: "The most flagrant deceptions have occurred in stock-option accounting and in assumptions about pension-fund returns. The aggregate misrepresentation in these two areas dwarfs the lies of Enron and WorldCom."

"Options are a huge cost for many corporations and a huge benefit to executives. No wonder, then, that they have fought ferociously to avoid taking a charge against earnings. Without blushing, almost every CEO has told their shareholders that options are cost-free."

Fiery words

These were fiery words, which led the world's biggest software company, Microsoft, to stop handing out options and adopt a more conservative accounting policy. The Redmond giant and others like it have created mounting pressure on other software companies too.

If Yahoo and Cisco and others properly expense options, they stand to lose hundreds of millions from reported profits, possibly even shifting to the red. They are vigorously fighting to prevent the changing accounting practice from becoming law.

But the fight has apparently been won. Just yesterday, another giant, Hewlett Packard, announced that its general assembly of shareholders had voted massively to expense options. Now the HP board has to accept the decision. Naturally, it is in a horrible conflict of interest, as most of the directors have options. If they accept the decree, HP's share price is likely to drop precipitously, hitting them in the pocket.

One of these days, Amnon Landan will have to make a decision. Should he follow Bill Gates' lead and bow gracefully, or wind up like Carly Fiorina, whose shareholders are forcing her to capitulate?

The moment Mercury begins to expense options, Landan will have to prove one of two things. Either that Mercury can stop handing out tremendous amounts of options to its people without raising salaries and still remain at the forefront of its sector; or that it can continue to lavish options on its employees while maintaining profitability.

There is no third option, we believe. Mercury probably cannot morph from a profitable company to a money losing one and stay at the vanguard. But what is certain is that if he runs a company in the red, Landan won't be Forbes' entrepreneur of the year again.