Based on Paul Scott’s analysis of ABDP’s recent interim results and the ensuing discussion, there seems to be a poor understanding, even amongst savvy investors, of the methodology through which share-based payment costs are calculated and the appropriateness or otherwise of including them in earnings-based valuations.

I was one of those confused investors, and the ABDP situation spurred me on to do some research to properly understand the share-based payment figure and to assess how share-based payments should be dealt with in a valuation process. It is the conclusions from this work that I am sharing here.

First, by way of background, On 11 July 2016 ABDP granted 1,337,122 options to its employees at an exercise price of 395p. One-third of the options granted vest on each of the first three anniversaries of the grant date, subject to the employee remaining with the company on each vesting date.

ABDP published its interim results on 25 April 2017. The headlines were based on results excluding share option costs. They claimed a pre-tax profit of £2.5m, up 9% on 2016, and EPS of 11.04p, up 5% on 2016. The Income Statement showed a very different picture, however, with the pre-tax profit of £1.7m, down 29% on 2016, and EPS of 6.65p, down 37% on 2016. The reasons for these differences was £806k of share-based payment costs.

The starting point to evaluating the share-based payment costs charged to the income statement in respect of these options is to assess their “fair value”. This is effectively the theoretical market price at which an employee could have sold those options (if the rules of the scheme allowed it and if a market for employee share options existed – neither being the case) at the date of grant. It is calculated using the Black-Scholes model.

According to the ABDP 2016 annual results (note 22), the weighted fair value of these options was 197.19p per share. Thus, the total value to be charged to P&L in respect of these options is £2.6m (1,337,122 options x 197.19p fair value). At in excess of one-year’s pre-tax profits, this is obviously a huge amount for ABDP.

The charge against the income statement is accrued on a flat line basis over the period between grant and vesting.…

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