Options value comes ... and goes at market’s behest

MINING entrepreneur Andrew Forrest provides a classic illustration of how share options, which are a key part of many remuneration packages, can be extremely valuable, and quickly become worthless.

Mr Forrest is best known as the chief executive and largest shareholder of iron ore miner Fortescue Metals Group, but is also chairman of aspiring nickel producer Poseidon Nickel.

It was in the latter capacity that Mr Forrest negotiated last year's most valuable share options deal.

He was granted 115 million share options and 5 million shares as part of a deal whereby he become Poseidon's non-executive chairman in July 2007.

The value attributed to Mr Forrest's options has varied widely, and depends crucially on the value of Poseidon's shares.

When the deal was put to Poseidon shareholders for approval in May 2007, the company commissioned a valuation report by accounting firm BDO Consultants.

BDO concluded that the options could be worth as little as $41 million and as much as $316 million.

Poseidon updated the valuation for its annual report for the year to June 2008. It concluded that the options were worth $226 million.

Add in the $8.7 million value of the five million shares granted to Mr Forrest and the total value of his remuneration reaches $235 million.

Today, the options would be worth a fraction of their former value - and arguably are worthless - because the market price of the underlying shares has collapsed to less than 20 cents.

When Poseidon negotiated the deal for Mr Forrest to join its board, it provided the standard, textbook rationale for the options.

"The purpose of the grant of Forrest options is to provide an incentive to Mr Forrest to assist in the achievement of the company's objectives...and to align his interests with shareholders," it said in a statement.

If the options were exercised and Mr Forrest became a major shareholder, "the incentive remains to contribute to the achievement of the company's objectives, derive shareholder return and increase the price of a share".

Mr Forrest's options have an exercise price of 40 cents each and a maturity of five years. In other words, Mr Forrest can exercise the options at any time over the next five years and buy Poseidon shares for 40 cents.

However the options, divided into five tranches, can only be exercised if the company's share price reaches defined levels.

The first tranche of 35 million options can be exercised only if the share price is sustained at 60 cents or more.

The final tranche of 20 million options can exercised only if the share price is sustained at $1 or more.

To put this in context, Poseidon's share price immediately before the announcement of the deal with Mr Forrest in May 2007 was 24 cents. The share price quickly jumped to $1.48 after the deal was announced.

BDO used these figures, and adjusted for a planned one-for-two capital reorganisation, when it prepared its valuations. That explains why its valuations ranged from $41 million up to $316 million.

When the options were formally granted to Mr Forrest, on July 2 2007, the share price was $2.14, resulting in the company's valuation of $226 million.

The collapse in nickel commodity prices this year has resulted in the share price of nickel stocks also collapsing.

Poseidon's share price has tumbled as low as 15.5 cents but the five-year term on the options means Mr Forrest still has plenty of time to engineer a recovery.

The Poseidon deal is similar to the options package that Mr Forrest negotiated with FMG nearly six years ago.

In that case, Mr Forrest was granted 100 million options with an exercise price of 8 cents.

He subsequently exercised the options to become FMG's largest shareholder and watched the price of his shares rise as high as $13.10 (after a one-for-10 share split), briefly making him Australia's wealthiest individual.

FMG's share price has dropped to about $2 currently, a far cry from its high point but still enough to make Mr Forrest a billionaire and the original options deal very lucrative.

Share options are popular with exploration companies because they offer the potential for large rewards, without having to spend valuable cash on high executive salaries or director's fees.

Mr Forrest takes this to an extreme - his options deals are potentially far more valuable than for other directors, and his cash income is very low.

Poseidon does not pay Mr Forrest any salary or fees, while at FMG, where he is chief executive, Mr Forrest's total income last year was a very modest $198,000.

The accompanying table indicates that many exploration companies grant options valued between $1 million and $2 million.

West Perth-based Greenland Minerals and Energy Ltd, which has an exploration program under way in Greenland, is an exception, on the generous side.

In July 2007, it granted options to five of its directors - in three cases, the options were valued at $11.3 million.

The recipients were managing director Rod McIllree, executive director Simon Cato and exploration director Jeremy Whybrow.

Each was granted 6.6 million options with a four-year maturity and an exercise price of 20 cents.

In the remuneration report in Greenland's latest annual report, the "fair value" of each option was judged to be $1.725.

The options 'vest' only if the company's share price reaches defined levels - the first tranche of 2.2 million options 'vest' if the share price stays at 50 cents or higher for 20 consecutive trading days, the second tranche at $1 and the third tranche at $1.50.

The deal was looking good until recent months. The share price traded as high as $1.36 and the company managed to raise $21.9 million last December in a share placement priced at $1.25 per share.

Since then, the share price has tumbled as low as 17 cents and is currently at 26 cents.

The value of the options may have evaporated but, in the meantime, Messrs McIllree and Whybrow are on salary packages of about $210,000 and Mr Cato was paid about $110,000 last financial year.