Ambivalence in RedmondMicrosoft ( MSFT), the world's largest software maker, is uncharacteristically divided on the thorny issue of expensing stock options.
|Microsoft's Options |
Expensing options would take a bite out of Microsoft earnings
|Year||Revenue(billions)||Option Expense||Exposure||Net Income w/o Options||Net Income With Options||EPS Excluding Options||EPS Including Options||Decline in EPS|
|Note: Numbers may not add up due to rounding. Source: Microsoft 10-K, Microsoft fiscal year 2002 results|
But that's not a huge amount compared to other software companies. Among 38 software companies, Merrill Lynch found that earnings per share would fall an average 59% in 1999, 98% in 2000 and 79% in 2001 if stock options were expensed. In addition, Microsoft's overall exposure -- the percentage of revenue affected by the option expense -- of nearly 9% in fiscal year 2001 is relatively low compared to other software makers, an analysis of 14 software stocks by Friedman, Billings, Ramsey found. Siebel Systems, by contrast, has an exposure of 35%, meaning Siebel's options were valued at more than one-third of revenue in the last fiscal year. If options were expensed, Siebel's fiscal year 2001 pro forma results would plummet to a loss of $1.02 per share from earnings of 49 cents a share without expensing options, according to Friedman. If options are expensed, particularly using the commonly used Black-Scholes model, Microsoft retains a strong position in the software sector on a couple of fronts. First, because volatility is one variable in the Black-Scholes model, Microsoft options will be valued lower than other software companies because its stock is less volatile, Friedman, Billings, Ramsey pointed out in an Aug. 1 note on stock options. Second, with nearly $39 billion in cash on its balance sheet, Microsoft can replace options with salary raises far more easily than other companies. "In this market, cash is king, and Microsoft has a lot of cash," Friedman software analyst Daniel Ives said. "When you look at some of its competitors, they're in a much more precarious cash position, where options are one of the only ways they're going to incentivize employees and bring them in." Friedman does not cover Microsoft. Indeed, Microsoft CEO Steve Ballmer said last week that over the past three years the company has increased its cash compensation "quite dramatically." But Microsoft execs seem to have a difference of opinion over options. During lunch last week, Chairman Bill Gates indicated he's in the Warren Buffett camp, supporting expensing stock options, said David Readerman, equity growth strategist for Thomas Weisel Partners, who has covered Microsoft for 16 years. But Ballmer told analysts that Microsoft intends to stand with the rest of the tech industry, which has lobbied heavily against expensing options. "The health of the technology ecosystem not only to us as a leader for the industry but to our customers is very important," Ballmer said. Ballmer added that a broad set of companies have predicted that expensing options could have "very, very gloomy" consequences. Some companies fear that expensing options could hinder technology innovation and also lead to more stock price declines as earnings fall. Readerman, who has a buy rating on Microsoft, suggested that one of those consequences already is being felt. "I think that the invisible hand of the market will price and value technology and telecom at the stock-option expense number, and I think as a result, multiples and valuations are adjusting as we speak," said Readerman, who owns Microsoft shares. His firm hasn't done any banking with Microsoft.
Keeping it on the Down LowBut Standard & Poor's software analyst Jonathan Rudy said he believes that Microsoft is being more than just a team player with its relatively low profile on the stock options issue. The company also is watching out for itself. "At this point, they don't need any more enemies, especially with trying to get the settlement through with the nine remaining states," said Rudy, referring to the nine states who are fighting for tougher penalties in the antitrust case against Microsoft. Rudy has an accumulate rating on Microsoft and his firm doesn't do investment banking business.
Still Opposed After All These YearsSemiconductor giant Intel remains one of the high-profile tech opponents to expensing employee options. Last year Intel spent just over $1 billion on options. Though the expense didn't show up on its income statement, stock options effectively would have consumed most of the company's profits in a lean year. If Intel had expensed its options in 2001, net income would have been slashed from $1.29 billion to a mere $254 million. Meanwhile, profits would have dropped 79%, from 19 cents to four cents.
|What a Difference a Year Makes |
Intel's options expense would gently nibble 2000's earnings, but would have been huge in 2001
|Year||Net income(billions)||Options expense (billions)||EPS before options expense||EPS with options expense||% Change|
|Source: Intel 10-K|