In 1993, Cisco Systems Inc. reported net income of $172 million on revenues of $649 million. At the time, it employed about 1,000 workers, but foresaw its headcount ballooning as the company embarked on a string of acquisitions that would create the telecom behemoth it is today. To accommodate that growth, Cisco began an office-space expansion that year and financed it with synthetic leases in order to preserve cash and leverage for its upcoming M&A. Destined to become all the rage in the 1990s, synthetic leases are off-balance sheet financial tools that unload debt to special-purpose entities, or SPEs. Their purpose: to allow high-growth, but cash poor or below investment grade concerns to get the use of sizable amounts of relatively inexpensive capital without hurting their debt to equity ratios.

The 1990s are over, and to a large extent, so too are synthetic leases. Thanks to Enron Corp., which buried a multitude of debt in its various SPEs, synthetic leases are now red flags to investors and regulators that corporate hanky-panky could be afoot. In 2002 Cisco paid $1.9 billion to extract itself from these clever arrangements, opting instead to put the real estate on its books. This was no big deal for Cisco, which in its fiscal 2002 fourth quarter boasted revenues of more than $4.8 billion and a net profit of $772 million in what was undeniably a bad year for the San Jose, Calif.-based company. Cisco no longer needed the synthetic leases from a liquidity perspective and felt their very existence–despite the fact that it dutifully disclosed them–was a negative for shareholders. "Cisco has grown so huge that the impact of the real estate has been minimized," observes Craig Lund, president of San Jose-based Lund Financial Corp., which put together more than 70 synthetic lease deals over the past decade.

Such may be the fate for most synthetic leases held by larger publicly traded companies, despite the fact that the Financial Accounting Standards Board (FASB) recently released regulations that provided a structure for maintaining synthetic leases in some form. "Balance-sheet transparency will be very important going forward, and I expect a significant number of companies–I can't give you an exact percentage–to opt to bring assets back on balance sheet, despite the fact that from an accounting point of view they don't have to," says Michael Rotchford, senior managing director of structured finance at Cushman & Wakefield Inc., a New York real-estate services firm.

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