Stock-based compensation in DCF
I've searched through the whole internet and didn't find the answer.
I know that the consensus is to treat SBC as an expense (not add back), as stated by BIWS, Damodaran, or even Warren Buffet. They assume that SBC dilute shares, therefore it should not be treated as a non-cash expense.
What I don't understand is the fact that if we treat SBC as a cash expense, it affects FCFF and dilutes shares on top of that. Isnt it double-counting?
If we add back SBC in FCF, the dilution will only impact equity holders.
Would really appreciate if anyone experienced could chime in, I struggle with the topic.
Think of firm value as like this: Firm Value = Equity + Debt hence FCFF = FCFE + FCFD.
Now we have the issue some of the Equity in the above is given out to other claimholders, so we have:
Firm Value = Equity (ours) + Equity (claimant) + Debt
When we compute value per share, we want to find our equity, exclusive of what someone else owns already.
Hence to find find value adjusted for the fact that we no longer own all of the firm:
Firm Value(Ours) = Firm Value (Total) - Equity (Claimant) = FCFF - SBC
Therefore the DCF Firm Value you arrive at implicitly takes care of any dilution from SBC. To find value per share, you would divide by total shares outstanding (all dilution impact is already reflected), assuming no other option exercise is taken place.
When you say "[] they assume SBC dilute shares hence should not be added back", it's not true, SBC decrease your VALUE (by reducing cashflows to you), dilution is hardly relevant in the justification for not adding back SBC.
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