352  Moving from Enterprise Value to Value per Share
Convertible Bond Hedges  When a company issues a convertible bond, the 
bond is sometimes accompanied by a complex derivative transaction to ef-
fectively increase the strike price.27 For example, Square, Etsy, and Twitter 
have all issued convertible debt with accompanying hedges. Investors prefer 
strike prices close to the current share price. Issuers, concerned about dilution 
from conversion into equity, prefer a higher strike price that lowers the odds 
of conversion.
In its annual report, Square reports, “The Company entered into convertible 
note hedge transactions . . . to effectively increase the overall conversion price 
from approximately $22.95 per share to approximately $31.18 per share.” To 
account for the value of the hedge, we use Black-Scholes to revalue the convert-
ible bond at the higher strike price. The convertible note hedge reported in Ex-
hibit 16.4 equals the difference between the original and synthetic bond price.
Although Square does not report the value of the hedge on the balance 
sheet or in the notes, the company does disclose that “the convertible note 
hedge and warrant transactions may affect the value of our Class A common 
stock.” Even with the recent improvements in accounting transparency, a dili-
gent analysis of the notes continues to be critical!
Employee Stock Options
Many companies offer their employees stock options as part of their compen-
sation. Options give the holder the right, but not the obligation, to buy com-
pany stock at a specified price, known as the exercise price. Since employee 
stock options have long maturities and the company’s stock price could even-
tually rise above the exercise price, options can have great value.
Employee stock options affect a company valuation in two ways. First, the 
value of options that will be granted in the future needs to be captured in the 
free-cash-flow projections or in a separate DCF valuation, following the guide-
lines in Chapter 11. If captured in the free-cash-flow projections, the value of 
future options grants is included in the value of operations and should not be 
treated as a nonequity claim. Second, the value of options currently outstanding 
must be subtracted from enterprise value as a nonequity claim. Note, how-
ever, that the value of the options will depend on your estimate of enterprise 
value. Your option valuation should reflect this.
The following approaches can be used for valuing employee options:
• Company-disclosed fair value. Start by searching the annual report for the 
company’s assessment of fair value. For instance, Square reports the “ag-
gregate intrinsic value” of employee options at $1.544 billion in the note 
on stockholders’ equity.
27 In the transaction, the company purchases a call option on its own shares at the original share price 
and writes a second call option at the preferred conversion price.