Everyone knows (if they know anything about computing) that Microsoft doesn't produce the most stable computer software around. What is less obvious is that there are some problems associated with their hefty growth over the last few years.
Microsoft has seen its stock rise in value manifold over the last few years, but may soon see a real problem that results from their rather intense growth combined with the use of stock options to attract new employees despite what are less-than-stellar salaries...
18000 employees times a deliberately overestimated guesstimate of $75,000 apiece leads to a salary tab of $1.35B.
Value of stocks if options are exercised:
363 million shares times on the order of $150 per share or $54 Billion
Value of shares, on a per employee basis:
$54 Billion divided by 18000, or $3M
This implies that employees are, on average, millionaires, simply on a stock ownership basis. This is not diminished too substantially by the issue of the (not necessarily known) exercise price. If options were issued two or three years ago, when stock prices were in the $30 range, it's likely that the strike price is somewhere in that range. Recent prices in the $150 range (December 1997) make the difference between strike and actual price large enough to make it highly worthwhile to exercise the option.
There's little question but that this is a sufficient quantity of stock to significantly dilute ownership by non-employees in the marketplace were employees to exercise their options.
The more serious problem is that this all leaves Microsoft with a "slippery slope." In order to continue to keep and attract staff, there are choices of:
Status quo (let options grow)
Which means that stock prices are increasingly diluted by employee options, which actually hurts employees too.
Increase salaries (cut options, increase wages)
Increasing wage bills, which hurts the cash position.
And it still does nothing about the $50B of outstanding options.
Grow the company (make the current set of options supported across a wider base)
Which also means increasing staffing, requiring hefty capital investment and usage of cash. Nobody is going to just give their business away to Microsoft. And adding staff means either redesigning the compensation system ($$$), paying new staff less (bad morale), or giving out more options.
Buy back stock to reduce dilution
They don't have enough money for this. Recent cash reserves of $9B can't cover $54B in stock.
Move jobs to cheaper places like India
Which makes no friends in political places, and certainly isn't going to lead to great staff morale.
Beyond that, Microsoft has messed enough companies up between rapacious buyouts, less-than-honest marketing, technology that doesn't work very well, staff raids (Borland and Novell come particularly to mind), and "joint ventures" that typically amount to organ donations (IBM, Digital, Sequent, Fulcrum) that the computer industry is full of people that would be happy to see them falter.
Licensing fees are increasing as they push NT Server everywhere, and it turns out that NT isn't cheaper than Unix once Microsoft starts charging the real rates that you pay when they're not courting you...
I'm not just talking out of my hat; there are some real references that document the "option" situation:
Copyright 1997 The Seattle Times Company, Oct. 7, 1997
By Miles Weiss Bloomberg News
WASHINGTON - Microsoft has suggested it would boost stock repurchase efforts that have failed to keep pace with the number of shares issued to employees.
The Redmond software giant relies on stock options as a substitute for high salaries and cash bonuses to attract and retain employees. At the same time, Microsoft buys back stock in the open market to prevent employee awards from diluting the value of shares held by investors.
However, a recent Microsoft regulatory filing highlighted a problem, stating that "despite recent increases in stock repurchases, the buyback program has not kept pace with employee stock-option grants or exercises." While Microsoft spent some $6.2 billion since fiscal 1990 to repurchase 154 million common shares, the company also issued 363 million shares under employee stock plans.
Microsoft may be planning to address the creeping increase in shares outstanding, which ultimately erodes shareholder value. Microsoft signaled in the regulatory filing that the company would tap its $9 billion in cash and short-term investments as of June 30 to buy back stock more aggressively than in the past.
Among other uses, these funds will be available to "fund an increased stock-buyback program over historical levels to reduce the dilutive impact of the company's employee stock option and purchase programs," Microsoft said in a filing Sept. 29 with the Securities and Exchange Commission.
The promise to buy back stock comes just months after Microsoft halted such purchases, stating that the shares had become too expensive. Microsoft shares have roughly doubled during the past 52 weeks and trade at 42 times estimated earnings for the coming year.
After spending some $3.1 billion on repurchases during the first nine months of the year ended June 30, Microsoft stopped buying shares in the fourth quarter. The company said in its fourth-quarter earnings release that repurchases would resume in fiscal 1998, but it didn't give any indication of how large the buybacks would be.
While company officials declined comment on the SEC filing, one reason behind the possibility of increased purchases may be Microsoft's bid to increase its dominant position in the computer software and Internet industries.
Microsoft must hire more people as it expands.
"Their headcount continues to grow substantially," said Sanjiv Hingorani, an enterprise software analyst at Furman Selz in New York. "People don't go to work for Microsoft purely on cash compensation. Almost every professional employee gets options."
Moreover, as the shortage of skilled computer experts grows more acute, Microsoft may have to boost the size of stock-option packages offered to prospective employees. This exacerbates the dilution of Microsoft shares caused by option awards.
Copyright 1997 The Seattle Times Company
...the marketplace values Microsoft at twice what it values Philip Morris, yet Philip Morris generates more operating cash flow than Microsoft's _revenues_. [...] Such disparities remind me of other "Nifty 50" time periods, which eventually came to dramatic ends with substantial declines in stock prices.
|--Donald A. Yacktman, [ Yacktman Funds 1Q 1998 report]|
It may be true that tobacco companies have some substantial potential legal liabilities what with various lawsuits due to the health hazards of tobacco. If there is any further penetration of less-than-robust Microsoft products into financial and health services industries, that may open them up to similarly substantial liabilities due to losses resulting from system crashes...
There appear to be some further analyses:
"We wouldn't have Windows today if it hadn't been for the Office group and the Windows group working together," Gates said, speaking by telephone from a computer hardware developers' conference in New Orleans. "It was the thinking that was done, being in one company, going after a new user interface, taking a huge risk, that we were able to create Windows."
(And making sure that Windows wasn't considered "ready to deploy" until it made WordPerfect crash...)
A Motley Fool article that indicates that "As far as I can tell, the single most lucrative product Microsoft (Nasdaq: MSFT) sells is its own stock. Microsoft receives almost as much cash inflow from the stock market as it does by selling goods and services. "
(Larry Ellison, of Oracle fame, takes the spot...)