As the tech economy continues to sober up, a crowd of companies has yet to feel the hangover from the stock market and real estate market bender that overtook Silicon Valley in the past two years.

Many companies may have a significant part of their cash tied up to pay for real estate development years in the future as part of an operational, also known as synthetic, lease. If you're looking at the cash value of companies that grew up fast in Silicon Valley at the end of the '90s to evaluate how they're trading in regards to cash levels, you may be misled.

Space-strapped companies such as

Inktomi

(INKT)

,

BEA Systems

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,

Novell

(NOVL)

,

Keynote Systems

(KEYN)

,

Yahoo!

(YHOO)

and

RF Micro Devices

(RFMD)

negotiated large construction projects at the heights of the real estate market using synthetic leasing.

As part of the lease terms, they put up a big chunk of cash to get construction projects rolling. That money often appears as "restricted cash" or as a "long-term asset" on the balance sheet, when, in fact, that cash will not become available in the future to fund operations. That money will buy the campus or headquarters building at the end of the synthetic lease.

The difference in cash availability can be stark. If you don't factor out the money from its synthetic lease, Inktomi could appear to be trading at 5.3 times cash, restricted cash and short-term investments listed in second-quarter numbers. Back out that synthetic lease money and the firm is trading for 12 times available cash.

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Dozens of companies locked in top-of-the-market prices for land purchases and campus construction in late 1999, 2000 and 2001, when square footage costs in Silicon Valley went from a typical $150 per square foot into the $400 range. The reduced value of this real estate will have to be accounted for when the land hits the balance sheet at the end of the synthetic lease.

That's what happened to handheld maker

Palm

(PALM)

. The company took a charge of 10 cents a share after escaping its synthetic lease and writing down the reduced value of the land it wanted to develop only six months earlier.

The heart of the matter is the synthetic lease, a financial vehicle that allows office space to be bought and built without showing up on the balance sheet. This is especially attractive to younger tech companies looking to provide a steep return on assets. Through the synthetic lease, a bank or other third party buys and builds the campus for the company through a complex set of legal and accounting requirements that require the company to put up a substantial chunk of cash.

The bank usually wants collateral up front. A tech company without a rating from Moody's or Standard and Poor's may put up 75% to 100% of the project cost in cash into an account that the bank will hold. On top of that down payment, the company pays interest on the money the bank used to buy and improve the land.

Synthetic leasing allows companies to keep the real estate off the balance sheet, and also to deduct interest payments and depreciation on the real estate. When the lease is up, the company can renew the lease, buy the campus or sell it to another company.

In an economy in which real estate values are heading skyward, the synthetic lease also locks in a price at the beginning of the project.

"When you're in a real estate market that is escalating daily, hourly in value, that's great. But if it's flat or, heaven forbid, going down, it's an obligation," explains Brian Griggs of real estate adviser Griggs Resource Group, who saw tech campuses go from being a luxury for well-established companies to mainstream as the San Francisco Bay Area real estate market grew cramped and then saw the commercial real estate market crater.

"That's the million-dollar question, is it worth 25% of what they pay for it or 50%?" Griggs said. "I don't think anyone's going to tell you it's worth 80%."

As with all accounting issues, some companies are straightforward about their arrangements, while others obfuscate cash commitments. "The whole point of a synthetic lease is that companies want it to be transparent; they don't want it to show up truly as asset. The companies don't own the asset really. It's their commitment to real estate," explains PricewaterhouseCoopers real estate transaction specialist Suzanne McElyea.

Inktomi is an example of a straight shooter, detailing its "synthetic lease" under the "Liquidity and Capital Resources" portion of its 10-Q; the company set aside $119.6 million for construction of a headquarters building. In the second quarter, Inktomi finished with $229.7 million listed under "Total cash and cash equivalents, restricted cash and short-term investments." But $119.6 million of that is earmarked to pay for that headquarters and it won't be at Inktomi's beck and call to fund operations.

Based on the last three 10-Q

Securities and Exchange Commission

files, Inktomi burned an average of $13.5 million a quarter. Erroneously factoring in restricted cash, Inktomi would seem to have 17 quarters funded. Taking out the cash from its restricted lease, the company actually can fund a little more than eight quarters with its cash and short-term investments alone.

Not all companies make it so easy. Keynote Systems is straightforward only if you are familiar with synthetic lease terms and know that interest payments are usually calculated off the London InterBank Offering Rate, or LIBOR. Keynote's "lease commitments" footnote explains that the company pays varying rates of interest "based on LIBOR" and has $85 million in an interest-bearing escrow account, included on the balance sheet as "restricted cash." On the balance sheet investors will see $340.5 million in cash, equivalents, short-term investments and restricted cash. Again, that $85 million eventually will buy an office building that was negotiated at June 2000 prices.

Ernst and Young's Gail Gannon agrees that writedowns could be in the future of companies stuck building bigger or more lavish space than befits bust times. If a company "is not enjoying its asset, not getting the benefit of that asset, then there's clearly an argument for a writedown."

There's no simple way for companies to get that collateral money back. As it went from rapid growth to downsizing trauma, Palm took drastic measures to terminate its $420 million synthetic lease designed in November 2000. The company applied $238 million it had put up as collateral to French bank Societe Generale on 39 acres in San Jose, Calif., to buy the land.

In an instant, $238 million that previously showed up on the balance sheet as restricted investments was gone. Palm took a $59 million charge to adjust the value of the land it purchased six months earlier and paid $20.4 million in fees to Societe Generale to nix the deal. Palm management now has 39 acres of San Jose land on its books, which it has to sell in a dismal real estate market to recoup cash. Not what you'd call the easy way out.

Real estate attorney Debra Summers of premier Silicon Valley law firm Wilson Sonsini points out a few other options for cash-strapped companies that want to get at their collateral money, and they aren't all that appetizing. A company could cancel the synthetic lease and get all or part of the collateral money back by taking out a traditional mortgage. Or it could go to a sale-leaseback lender, but that type of deal wouldn't lock in the purchase price for the project ahead of time. Summers says she's seen many companies extend their synthetic leasing deals.

Companies that have enough cash to make it through the downturn don't have to go through the Palm scenario. But they could have to adjust the value of their monster real estate deals once they take it over. Most importantly, they certainly don't have their restricted cash in pocket to spend in times of need. They'll have to take a few aspirin and wait for morning.

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