Dell Is Buying Back Some Stock At Almost Twice the Market Price

By Gary McWilliams
Staff Reporter of The Wall Street Journal

As a result of an employee-compensation plan gone awry, Dell Computer Corp. is shelling out $47 a share to repurchase some of its own stock, even though the stock is currently trading at around $24.

In fact, during the past four quarters, the Austin, Texas, personal-computer maker has paid a premium of about $750 million above its stock price to repurchase shares from financial institutions, according to its most recent financial statement.

The now-costly commitments to buy its shares were made by Dell as part of a strategy to minimize the cost of granting stock options to employees.

Under the strategy, Dell sold puts, or contracts to buy its shares at specified prices, receiving about 75 cents for each put. Over the years, Dell used the proceeds to offset the cost to issue shares. Until last fall, those puts expired, worthless, as Dell's stock price was above the price set to exercise the puts.

Now, the slumping market for PC stocks is producing big losses on the repurchases at a time when Dell's vaunted cash generation has been squeezed by the PC slump and its own pursuit of a price war. For the past three quarters, the average closing price for the company's stock has been as much as $22 a share below the put exercise price.

For the fiscal first quarter ended May 4, Dell spent $751 million on stock repurchases, or 91% of its cash flow from operations.

Dell isn't the only company buying back such puts. Microsoft Corp. has been making similar premium-priced purchases. But analysts say the huge liability of retiring Dell's puts could affect its ability to make acquisitions and comes as its cash-flow engines are downshifting.

"If it wanted to do nondiluted acquisitions with cash, it has in some sense precluded that," says Charles R. Wolf, a Needham & Co. computer analyst. "It was a foolish mistake to sell puts in the first place. There is an element of hubris on the company's part to think it could grow the stock price forever."

Dell executives have said recently they would consider "strategic" acquisitions, which Wall Street believes would help it diversify into higher-margin businesses, such as services.

A Dell spokesman said the puts have been part of a stock-buyback plan under which Dell has so far repurchased 887 million shares at an average price of less than $9 apiece.

"These puts have helped minimize the expense of the program overall," the spokesman said. He declined to make a finance official available for an interview but said Dell would be willing to dip into its cash reserves of $5.27 billion (as of May 4) to repurchase the shares.

Meanwhile, the cash drain could continue for some time. According to its latest Securities and Exchange Commission filing, Dell has written put contracts on 96 million shares at an average exercise price of $44 a share, representing a liability -- in a depressed market -- of $4.22 billion.

The contracts expire at various times up to May 2, 2003 and allow the company to exercise the options with cash or stock. But Dell doesn't plan to issue shares, which would dilute its earnings per share.

In 4 p.m. Nasdaq Stock Market trading Monday, Dell fell 40 cents to $23.92, well off its 52-week high of $54.67, set July 18, 2000.

Thomas I. Selling, an accounting professor at the American Graduate School of International Management, Glendale, Ariz., called the link to stock compensation irrelevant. "It really is speculation, no matter what they say," he says. "It's arbitrary to match this put program with the stock-compensation program."