Options Rule Is the Latest Headache for Tech

For 2004, Microsoft's earnings would fall 21 cents, or 18%, to 98 cents after accounting for the cost of options.

Meanwhile, Wall Street's reaction to reforms at Microsoft underscore that it's not just corporate policies that matter. Equally important is whether analysts pay any attention. Microsoft's move last year to begin voluntarily expensing options when it reports earnings has been largely ignored, with most analysts leaving the options expense out of their estimates. Thomson First Call has followed their example.

Sanford C. Bernstein analyst Charlie Di Bona wanted Thomson First Call to post Microsoft estimates that include options expensing, but the firm rejected his request. "My feeling is if they are not going to take responsibility for setting the rules themselves, they should at least let the buy-side determine it -- not the sell-side," Di Bona charged. (He has a buy rating on Microsoft; his firm doesn't do investment banking but its parent, Alliance Capital, holds Microsoft shares.)

Right now, those who exclude Microsoft's option expense argue that it makes for an easier apples-to-apples comparison with software vendors that don't expense options.

Until the accounting rule change actually goes into effect, Thomson First Call said it will not break out earnings estimates that include stock options expenses if the majority of sellside analysts don't want to provide them, according to research analyst Ken Perkins.

To be sure, plenty of money managers say they already figure out the impact of options, leading some to argue that the shift to expense options is mostly factored into tech stock prices.

Todd Ahlsten, manager of the Parnassus Equity Income fund, said studying Intel's(INTC) spending on options-related share buybacks has helped him more accurately estimate the company's discounted cash flows and therefore value the stock. (He doesn't currently hold the stock because he considers the valuation relatively high, but says he likes the company and has owned it in the past).

At Stein Roe Investment Counsel, buyside technology analyst Chuck Jones said he already tracks trends in options issuance and considers what earnings would have been after expensing, also noting how much companies generate in cash flow and what they spend on share buybacks.

In that sense, the focus on options expensing is part of a broad trend toward a more cautious evaluation of tech companies' prospects. "Whereas before we were driven by this vision of unlimited opportunity, now investors in technology still have optimism. But today they are starting to realize it's not unlimited," said Vadim Zlotnikov, chief strategist at Sanford Bernstein.

Dude, Who Took My Profits? Estimated percent decline in profit at leading chipmakers
Company	2004	2005
Intel	12.3%	10.1%
Texas Instruments	23.5	16.7
Advanced Micro Devices	58.3	38.8
Linear Technology	24.1	18.6
Maxim	33.2	24.1
Analog Devices	39.0	25.8
Source: SG Cowen. Option expense estimate based on Black Scholes.

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