Other companies are using real options applications in farther- reaching applications. General Motors and Ford, for instance, are developing applications for automobiles using the global positioning system (GPS) satellite network in combination with wireless technology.
Getting Exercized
Given the valuation discrepancies, most Wall Street analysts remain skeptical about real options analysis. Even a notable exception, Michael Mauboussin, managing director of Credit Suisse First Boston (CSFB), is careful to take into account a company's management and culture when valuing the options he deems it to possess. "Just because a company has certain options doesn't mean they'll be intelligently exercised," he says.
Laura Martin, a CSFB equity analyst, made much the same point as far back as July 1999, when she applied real options analysis to the cable industry. In her report, Martin concluded that Adelphi Systems's cable TV options were anywhere from four times to eight times more valuable than those of such competitors as Comcast, Cox Communications, and Time Warner, simply because more of Adelphi's assets were devoted to cable and the company was more highly leveraged.
Today, of course, the wherewithal of these and other companies to exploit their options has been reduced by the recent downturn in the capital markets. As Mauboussin puts it, "An option isn't of much value if you can't fund it."
In the end, BU's Kulatilaka suggests that real options analysis is more useful in conceptualizing projects than in evaluating them. That way, he says, "you use them to push the organizational change" required to make a project live up to its potential. But if such change is necessary in the first place, green-lighting a project based on real options analysis amounts to putting the cart before the horse. And CFOs at such companies can't be blamed if they prefer to give NPV the reins for at least a little while longer.
Ronald Fink (ronaldfink@cfo.com) is a deputy editor at CFO.
WHOSE OPTION IS IT, ANYHOW?
The real value of a real option may have as much, if not more, to do with the nature of the holder than with that of the option.
The typical real options analysis, for instance, would assume that automotive applications based on GPS-wireless (also known as telematics) applications represented--at least at the outset--the same opportunity for both Ford and GM. And that each, therefore, possessed the same options and faced the same decision about investing in them. But because the companies have approached the technology so differently, the value of their options has also turned out to be different, according to Boston University finance professor Nalin Kulatilaka. GM's system, called OnStar, was reportedly designed, at least at the outset, to provide little more than navigational and other assistance to drivers. Ford's system, Wingcast, produced in a joint venture with Qualcomm, is designed to offer full Internet access and, say analysts, is based on technology that allows new features to be added more easily than GM's.
"GM looks at OnStar as another automotive feature," says Kulatilaka. A spokeswoman for GM disagrees, saying that the technological difference between the two systems is exaggerated, and that OnStar now offers virtually everything that Ford claims Wingcast will. OnStar "started with safety and security," she says, "but it has evolved since then."
Yet Ford's greater ambitions were clear from the start. Said Ford CFO Jacques Nasser, when the company announced its investment in Wingcast in July 2000: "We are...transforming the automobile into the next mobile portal." And, says Kulatilaka, "that's where the true value is."
Granted, GM is way ahead of Ford in rolling out its system. While GM began offering OnStar on 3 Cadillac models in 1996 and is now offering it on 32 of the company's 54 models overall, Wingcast has yet to be introduced. What's more, analysts worry that customers may not be willing to pay much, if anything, for even the most basic service, so cash flows may fall well short of projections.
"OnStar is less flexible than Wingcast," concedes Domenic Martilotti, an analyst at Bear, Stearns & Co., "but how willing are customers to pay for [Wingcast]?" He notes that OnStar is free for the first 12 months, and that while the company claims 60 percent of owners of OnStar-equipped cars renew for the annual subscription price of $199 to $399, GM hasn't said how many of those are Cadillac owners, who tend to be wealthier than other GM customers. Yet if, as some analysts expect, Ford ends up delaying or even ending its investment in Wingcast while GM continues to fund OnStar despite disappointing results, that would only support Kulatilaka's contention that Ford's option on telematics applications was more valuable than GM's because of Ford's greater discipline. -- R.F.
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