From: Bollers (boller@corecomm.net)
Date: Tue Feb 22 2000 - 08:08:22 PST
If a company structured like this were to oneday find itself in a market
death spiral for it's products, things could crash *particularly
ugly*......or would the company actually find *itself* cushioned most of the
way down?
DAB
David Alan Boller
______________________________________________
Fountain Valley, CA
> -----Original Message-----
> From: fielding@ebuilt.com [mailto:fielding@ebuilt.com]
> Sent: Saturday, February 19, 2000 3:58 PM
> To: fork@xent.com
> Subject: fwd: Microsoft's Genius
>
>
> ----- Forwarded on 02/19/00 03:56 PM -----
>
> Why Microsoft's Stock Options Scare Me
>
> By Rob Landley
>
> Forget Windows 2000. As far as I can tell, the single most
> lucrative product Microsoft (Nasdaq: MSFT) sells is its own
> stock. Microsoft makes almost as much after-tax cash income from
> the stock market as it does by selling goods and services.
> Here's how:
>
> Basically, Microsoft receives cash by issuing employee stock
> options, after which the company then receives billions of
> dollars in tax deductions from the IRS for doing so. Add in the
> warrants it sells on its own stock, and the company made over $5
> billion off the stock market last year (fiscal year ended July
> 1999), tax-free. For comparison, its after-tax net income was
> only $7.8 billion. Microsoft may not be much in the programming
> department, but its accountants are impressive.
>
> Let's run through that again a little more slowly, using
> Microsoft's most recent annual report. As with all annual
> reports, the most interesting stuff is in the tables at the end.
> In this case, search for the $3.1 billion dollar item "Stock
> option income tax benefits," which occurs in the Financing
> section of the Cash Flows Statement (the above link will take
> you there). Lemme detour for a sec to explain what "Stock option
> income tax benefits" are.
> http://www.microsoft.com/msft/ar99/cash.htm
>
> A significant portion of the wages Microsoft pays to its
> employees comes in the form of stock options rather than in
> cash. Compared to the rest of the industry, the amount of cash
> Microsoft pays its programmers is at best mediocre. It attracts
> and retains employees via stock options.
>
> These options give the employees the right to buy a certain
> number of shares of Microsoft stock at a tiny fraction of the
> current market price. Employees can even take an automatic
> payroll deduction to make the token payment to exercise each
> stock option as it matures, and thus effectively get shares of
> Microsoft stock as part of their wages.
>
> Microsoft's options are "non-qualified," which means the
> employee is immediately taxed when an option is exercised (i.e.,
> used to actually purchase very cheap stock). The difference
> between the price the employee pays for the stock and the
> current market price for the stock they receive is counted as
> taxable income on the employee's W-2 tax form for the year, as
> if they'd received it in cash. The cost basis for the stock is
> adjusted accordingly, meaning that if the employee immediately
> sold their newly acquired Microsoft shares they wouldn't incur
> any additional taxes. They've already been taxed on that income
> anyway, and the only new taxes to accrue are capital gains taxes
> if they sell the stock for a higher price than they bought it
> at. (Capital gains taxes apply to the extra money gained by
> selling an investment for more than it was purchased for. Only
> the amount over the original purchase price -- the cost basis --
> is taxed, and this has nothing to do with options.)
>
> Corporations pay taxes on their own income (generally 35%), but
> money they pay out in salaries to employees is deductible from
> the corporation's income. Since granting options to employees
> results in taxable income to those employees, Microsoft gets to
> deduct that taxable employee income from its own taxable
> corporate income, and that's where Microsoft got a tax-free $3.1
> billion in cash in fiscal 1999: "Stock option income tax
> benefits."
>
> But if you stop and think about it, Microsoft didn't really have
> to spend actual money to provide the options. It even GOT a
> little money from its employees, in the form of the cash the
> employees paid (via payroll deductions) to exercise their
> options. All Microsoft had to do was issue new stock
> certificates, which more or less involves taking a vote in a
> board meeting and then firing up a laser printer.
>
> So Microsoft got $3.1 billion of tax money back from the
> government, which at a 35% tax rate would be in exchange for a
> $9 billion tax expense it never had to pay. Its employees got
> taxed and paid that tax out of their own cash wages, and
> Microsoft got the money refunded back into its corporate
> coffers. It even got $1.3 billion of cash BACK from its
> employees in that payroll deduction to exercise the options (the
> "Common stock issued" line item, in the same Financing table as
> the "Stock option income tax benefits"). Together, that's almost
> $4.5 billion dollars Microsoft made directly from selling stock.
>
> This is on top of a huge cash savings from substituting shares
> of its stock for actual cash paid to employees in the first
> place. Remember, Microsoft only made a $7.8 billion net profit
> last year. To pay its employees an extra $9 billion in cash
> compensation expense, it would go $1.2 billion into the red.
> But it doesn't have to, as the stock market provides the money
> to keep Microsoft going. Microsoft prints stock, pays its
> employees with the stock, and the stock market provides the cash
> for Microsoft's employees when they sell the stock or get margin
> loans against it. Microsoft can print as much stock as it likes
> in order to pay its employees, and as long as the market keeps
> wanting to buy shares from those employees, then Microsoft
> doesn't have to spend too much of its own cash to pay its
> people. As of July '99, Microsoft had around $60 billion of
> employee stock options outstanding, and it grants more all the
> time.
>
> Of course printing more stock dilutes the value of Microsoft's
> existing shares, but as long as the stock price keeps going up
> nobody seems to mind. Microsoft can sell more and more stock
> (through its employees) at ever-higher prices to generate more
> and more income with which to support the stock price in a
> never-ending pyramid, er, cycle. And of course Microsoft can buy
> back some of its shares -- $3 billion in 1999 ("Common stock
> repurchased" in the same Financing table as before) -- but since
> it issued over $10 billion worth of shares ($9 billion taxable
> income over and above the $1.3 billion the employees paid for
> it), this buyback is a mitigating factor at best. But since a
> lot of Microsoft shareholders hold on to their shares and live
> on margin loans, the dilution doesn't increase Microsoft's share
> float until they do decide to sell (i.e., the stock starts going
> down and they have to pay off those margin loans). Meanwhile,
> the buybacks help keep the stock price from dipping too much.
>
> Employee options aren't the only kind Microsoft sells. It sells
> another kind called "put warrants" to mutual fund managers,
> giving them the right to sell Microsoft shares back to the
> company at a fixed price (well below the price they're currently
> trading at, of course). Mutual fund managers with a large
> exposure to Microsoft stock buy warrants as insurance, giving
> them a guaranteed floor price they can sell out at if the stock
> collapses. If the stock doesn't collapse, the warrants expire
> worthless after a few years, and provide Microsoft with
> additional revenue (three quarters of a billion in 1999, "Put
> warrant proceeds" in the cash flows statement).
> http://www.fool.com/LunchNews/1999/LunchNews990521.htm
>
> So there you have it. $3.1 billion from a tax loophole, $1.3
> billion from its employees, and $0.7 billion from put warrants
> combine to give Microsoft over $5 billion from its own stock in
> fiscal 1999. And it avoided paying $9 billion in wages. All that
> from a company that only had $7.8 billion in net income. And as
> long as the stock keeps going up, they can keep doing that ad
> infinitum.
>
> Maybe if Microsoft had recruited a few people from their
> accounting department into the programming staff, they'd have
> gotten Windows 2000 out on time, eh? Then again, who cares
> about products if you can make this much money without them?
>
>
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