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Stock Options Cloud Merger Perspectives

The acquisition of Sun by Oracle is casting a large shadow that obscures a couple of other potentially important acquisitions in the tech world. One acquisition target, niche storage vendor Data Domain, has rejected an all-cash offer from EMC in favor of what seems like a less lucrative offer from NetApp, while another possible target, networking equipment vendor Emulex, is steadfastly rejecting a hostile bid from Broadcom.

At a time when many investors would be happy for any outcome that translates into more cash, you have to wonder if management at Data Domain and Emulex have lost their respective minds. But as usual, their actions may be more a case of self-interest trumping shareholder interest -- and forget the canards about culture and independence altogether.

The case of Emulex and Broadcom is relatively straightforward. Emulex claims that Broadcom is undervaluing it and claims it has superior technology and market positioning. Emulex CEO Jim McCluney said in a statement that

Emulex is well positioned for significant and rapid growth through our leadership in the converged networking market. We are securing design wins, in many cases against Broadcom, which is threatening their current and future Ethernet business.
Management claims this superiority will translate to long-term shareholder value, but given current market volatility and Emulex's historically low trading range (it hasn't traded over $23.40 in the past five years), you know something else is afoot.

That something else is McCluney's compensation, which would actually take a bit of a hit in the event of a change in control. According to company filings, the market value of McCluney's unvested stock options is around $1.8 million. But the company's compensation plan provides that McCluney's vesting is only accelerated by a year in the event of change in control, meaning he wouldn't get the full $1.8 million. The market value of his vested options at the time of last year's filing was around $1 million, meaning he could lose several hundred thousand dollars worth of stock in the event of a change in control.

Meanwhile, McCluney's total compensation in 2008 (including cash and stocks) was $3.5 million, a fairly handsome sum for a company with a market cap of $896 million. By comparison, Frank Slootman, CEO of Data Domain, which has a $2.04 billion market cap, earned $275,000. Data Domain's compensation committee determined his compensation package was "below median competitive practices" and created an incentive package to compensate for that slight. Despite the package, all Slootman could do was double his salary to $550,000.

On the other hand, the company's compensation policy also stipulates that, in the event of a change in control, "100% of his unvested option shares, restricted shares and/or restricted stock units will vest."
So in the event of an acquisition, Slootman would be entitled to cash in on more than 1.6 million shares he already owns, plus another 100,000 of unvested Data Domain stock options. The NetApp offer of $30 per share breaks down to $16.45 per share in cash and the balance in NetApp stock, which currently trades at just under $20 per share.

So it's clear that McCluney has no incentive to accept Broadcom's bid, while Slootman has every reason to accept an offer -- but why favor NetApp over EMC? Is it really for the cultural issues the company's executives bring up? Most failed mergers founder on the rocks of corporate and personal personality clashes, so Slootman would be wise to take that into consideration if he has the new company's interests at heart. Or is it the $57 million termination fee Data Domain would have to pay NetApp if it decided to accept EMC's offer? That seems like chump change in the context of this deal.

Perhaps NetApps' offer is more attractive to Slootman personally because won't have to pay taxes on the value of the stock that's paid as part of the acquisition.

[Image source: Wikimedia Commons]

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