MegaFon to use real rather than phantom shares for management motivation

«The operator has 3.92% of quasi-treasury shares for such occasions

July 12, by: Elizaveta Sergina


MegaFon is preparing to update its stock options plan and may decide to distribute ordinary stock rather than phantom shares, MegaFon’s spokesperson Yulia Dorokhina said refusing to provide details of the discussion, but adding that the new motivation program aimed at the management and key employees will be proposed to the company’s Board of Directors for consideration together with the new development strategy.

In 2012 and 2013, the Russian cellular operator’s Board of Directors approved two versions of long-term motivation programs with options for key executives and directors to receive phantom shares. Each share is valid for three years, and the holders can only exercise the options and earn money in the second and third year of the program. Managers are paid the difference between the weighted average stock price for the period between January 15 and March 15 of the respective year and the predetermined base price. The initial base price was set equal to $17.86 per share for the 2012 program and $24.25 for the 2013 program. In 2015, however, MegaFon’s Board of Directors revised the terms of these programs setting the base price equal to 555 rubles and 744 rubles per share, respectively. The total value of the phantom stock is 1.1% of the company’s share capital.

Dorokhina would not explain whether the company intended to repurchase shares in the market if the new motivation program is given effect. The operator currently has 3.92% of quasi-treasury shares registered on the balance sheet of its Cyprus-based subsidiary company Megafon Investments.

MTS mostly uses phantom shares for motivation, the company’s President Andrei Dubovskov stated in a recent interview with Vedomosti. More than 500 people are participating in the company’s motivation program which only applied to members of the Management Board until recently, Dubovskov said. Rostelecom has been implementing a motivation program for 200 top executives since 2014 offering them treasury shares. The program covering 1.5% of the ordinary shares may be extended to 3% in case certain KPIs are exceeded. Besides, Rostelecom is developing a new program covering 6.25% of the securities. Employees of Russia’s VimpelCom participate in the option plan of the parent international holding company Vimpelcom ltd, while Tele2 has not launched any option programs.

According to Alexander Shevchuk, Executive Director of the Association of Institutional Investors, payments to employees can be regarded as bonuses in the phantom stock case, which entails payments of insurance contributions to the social security scheme – as opposed to real securities. Otherwise, the use of real or phantom stock does not make any difference to the company, as all the payments are made out of the company’s profits anyway. With non-deliverable options, the company can just as well pay only the difference between the base price and the market price to participants, while delivery options make managers real shareholders, unlike the phantom stock scheme.

What does make a difference is the employee stock ownership plan (ESOP) when the company sets up a closed-end mutual fund and the ESOP participants own shares in it, Shevchuk says. The scheme may assume advance payments by the mutual fund members. It is the market that actually pays for the growing stock value then, an obvious cost saving opportunity for MegaFon.

According to Natalia Milchakova, deputy head of Alpari's analytical department, an option plan based on real instead of phantom stock may turn out to be a more effective long-term motivation instrument for managers of public companies. The ownership of a share package would grant them all shareholder rights, entitle them to dividends and ensure income from the disposal of shares (if any), while the phantom shareholding is primarily a bonus calculation instrument, she explains. It would be reasonable for MegaFon to use quasi-treasury securities for the option plan, Milchakova says.

An option plan based on real securities is a better choice for employees, according to an ex-top manager of a large telecom carrier. Phantom shares are pegged to a certain date, and a weak market means little profit. On the contrary, the sale of real shares can be postponed until they go up in price, he adds.

A special case

MegaFon’s previous CEO Ivan Tavrin had an option for real, not phantom shares. He acquired a 1.25% stake in MegaFon from Megafon Investments after the IPO in December 2012, exercised the option for another 1.25% in May 2013 and had the right to purchase another 2.5% starting from May 2014 which he waived as MegaFon’s stock price plunged below the base level of $20. In January 2015, Tavrin exchanged his 2.5% shareholding in MegaFon and the purchase option in respect of another 2.5% for a stake in the parent company USM Holdings Ltd.

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