How eBay Cashes In on Employee Options

Investors feel part of the brunt of options through dilution. Options exercises at eBay last year, for instance, amounted to 3.5% of the shares outstanding at the beginning of 2002. As the company granted options equivalent to 4.2% and 5.8% of outstanding shares in 2002 and 2001, respectively, more dilution will be coming down the pipeline.

But beyond dilution, options can have a perverse effect on valuations.

eBay's stock price, which closed at $101.65 on Friday, has grown nearly 50% in value this year. Part of its appreciation can be attributed to its growth in earnings and its ability to generate cash.

In a research note issued after the company posted its first-quarter earnings last month, Smith Barney analyst Lanny Baker, for instance, touted eBay's cash generation in the quarter.

"Free cash flow provides the best illustration of eBay's financial might: Up 80% year-over-year to $146 million in the quarter, representing an impressive 31% of revenue," Baker wrote. "eBay's cash balance continues to swell, now to over $2 billion."

In setting a price target for eBay, Baker again pointed to the company's cash generation, putting a valuation on the company equal to 55 to 60 times its estimated 2003 free cash flow.

But Baker did not mention in his report how much of eBay's free cash flow or its overall cash is coming from options. (Smith Barney does not have any investment banking business with eBay.)