How eBay Cashes In on Employee Options

Trying to determine a fair valuation for eBay -- or many other technology companies -- is difficult because of the aberrations caused by options, said one hedge fund manager, who asked not to be named. Free cash flow is distorted by the tax benefit from options. And the bottom-line earnings number is often distorted because companies don't expense options.

"How do you make sense of that? The entire industry needs to face that," said the fund manager, who does not have a stake in eBay. "Someone's got to take Silicon Valley to task on this. From a shareholder's perspective, they are stealing from us."

Last year, the average exercised option at eBay had a strike price of $26.16. In contrast, the average closing price of the company's shares last year was $58.97. While that difference between market price and exercise price represents a windfall for employees, it also represents an opportunity lost for the company. That difference means the company likely saw less than one-half of the market value of its stock for each option that was exercised.

It also points to a fairness issue and other red flags, said Lutin. The sheer amount of stock being exercised at eBay is tantamount to a public offering. But at such an offering, the market would get to determine the price of the excess shares.

Instead of a public offering of shares, though, the company is restricting to insiders the opportunity to buy stock at deeply discounted prices, while forcing outsiders to pay what is essentially an inflated market price for it, Lutin said.

"It raises real questions of fairness."