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HHGregg throws lifeline to employees with underwater options

April 13, 2013

HHGregg Inc. employees who hold stock options are getting a do-over, something many investors who bought the company’s shares for as much as $30 apiece wish they had, as well.

The company this month filed papers with the Securities and Exchange Commission giving option holders the right to exchange their current holdings for new options with an exercise price set at the current market price.

No doubt, the change approved by the board is going over well inside HHGregg’s East 96th Street headquarters, where spirits already were improving thanks to a recent rally in the company’s shares.

Investor optimism is growing that HHGregg can overcome plunging large-screen TV sales, in part by upping its emphasis on appliances. Even so, the long-term trend is painful, with shares falling 57 percent, to around $13, since their May 2010 peak.

Options give holders the right to buy shares in the future on the price on the date of grant. Because of the decline in HHGregg’s stock price, the top brass and other key employees hold some options that seem hopelessly underwater, with exercise prices in the high $20s.

An HHGregg spokeswoman declined to comment on the exchange offer, which covers options issued at various times since the company went public in July 2007 at $13 a share. In the SEC filing, the company says that employees have to exchange either all their options or none, and that the new options won’t vest for three years.

“We believe the offer will foster retention of our employees and better align the interests of our employees and stockholders to maximize shareholder value,” HHGregg said in the filing.

Corporate governance watchdogs acknowledge that it can be demoralizing for employees to hold options that seem sure to remain worthless, a scenario that could cause them to look for work elsewhere.

But the watchdogs say that lowering the bar by issuing new options isn’t fair to shareholders and undermines options’ effectiveness as an incentive that encourages strong management.

“I’ve never been a big fan of that,” Charles Elson, director of the Center for Corporate Governance at the University of Delaware, said of option exchanges. “It’s a contract. If you haven’t made the goal, you shouldn’t get another bite at the apple.”

He added: “Heads I win, tails I win doesn’t make a lot of sense from an incentive standpoint.”

Such moves are relatively uncommon, in part because they engender scorn among institutional investors, which sometimes will retaliate by voting against compensation committee members up for board re-election.

Another approach that’s at least as controversial is exchanging underwater stock options for restricted stock—a move that ensures recipients end up with something of value even if the stock price doesn’t climb a penny.

Emmis Communications Corp., which trades for around $1.60, did such an exchange in February, which helped bail out employees who held options with exercise prices as high as $14.21 a share.

Under the exchange formula, employees holding barely underwater options converted into more restricted stock than did holders of deeply underwater options. The final tally: Seventy-five employees cashed in 2.2 million out-of-the-money options for 511,065 shares of restricted stock worth $817,704.

An Emmis spokeswoman said Emmis CEO Jeff Smulyan and Chief Operating Officer Pat Walsh were attending the National Association of Broadcasters convention and were unavailable to comment.

In an SEC filing, the company said, “Our board of directors believes that Emmis employees do not perceive value for out-of-the-money options.”

As a result, it continued, the options available to exchange “do not provide any retention benefits to the company.”

Ultimately, Emmis argued, shareholders win as well, by increasing the motivation of employees to boost the stock price.

HHGregg stock lights up

In late October, HHGregg stock hit an all-time low of $5.84 apiece, and it hovered in that range for weeks. But in early January it caught fire, climbing steadily before reaching its 52-week high of $13.13 on April 10.

Driving the resurgence, according to analysts, is the recovery of the housing market, which has stoked demand for appliances and TVs, and a growing sense that the leading companies in the sector, including Best Buy and HHGregg, are getting traction from changes to their business models.

“The worst is behind as consumers begin to show signs of recovery, and new product cycles hint at emerging upticks in some categories,” B. Riley & Co. analyst Scott Tilghman told Investor’s Business Daily.

“But ultimately, companies will have to manage their cost structures and their differentiation to effectively compete in the coming years of these new cycles.”•

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