Let me explain. In late April, with bad news multiplying like last week’s “I Love You” virus, Microsoft gave about 70 million new stock options to its employees to make up for the stock’s decline since July, when it had awarded its customary annual grants of new options. The July options gave holders the right to buy Microsoft stock at about $86 a share, by my reading. (The company declined to comment.) The April options, though, were at 66c, the stock’s price the day the options were awarded.
This screwy situation that caused Microsoft to issue a whole new set of options is a fallout from the battle five years ago when tech companies succeeded in blocking rules that would have counted options as an expense at the time that they’re awarded. For arcane reasons, FASB rules now require options that are repriced to be charged against profits, but doesn’t require fixed-price options to be charged. Having to charge the April options against profits could easily cost Microsoft $30 billion of pretax earnings over the options’ seven-year life. That would gut Microsoft’s reported profits and probably whack its stock price, which is heavily dependent on its earnings prospects. (Repricing is typically done by the likes of barnesandnoble.com, which don’t much care about reported profits. And it attracts unwelcome attention from shareholder-advocate types who complain that options holders, especially top executives, are getting a far better deal than regular shareholders get.)
According to an analysis by WestWard Pay Strategies of San Francisco, the July options were worth about $1.4 billion when the new options were awarded in April. (There’s no room here to explain why 70 million underwater Microsoft options have such a large economic value. It has to do with how the famous Black-Scholes options-pricing formula works. Just trust me.)
Microsoft wouldn’t say whether accounting considerations played a role in its decision to issue new options rather than reprice the old ones. Clearly, they did. Either Microsoft bestowed $1.4 billion of extra value on its employees because it felt especially benevolent, or it did so to avoid screwing up its reported profits. I’ll pick profits. As does watchdog Patrick McGurn of Institutional Shareholder Services. “They’re doing the economically rational thing,” he says.
So, in a magnificent irony, Microsoft’s accounting tail is wagging the dog. And Microsoft employees were the beneficiaries. “We haven’t gotten any thank-you notes from Microsoft employees,” quips Timothy Lucas, FASB’s director of research. Maybe that’s because the Softies are so busy answering their “I Love You” mail that they haven’t been able to find the time to write.
Awe, well: When I wrote about AT&T’s Wireless tracking stock in last week’s issue, I had no idea that AT&T would announce a revenue shortfall last week and both AT&T and AWE would get zapped. The market now values Wireless at more than it values AT&T Classic after you subtract the value of the 1.95 billion Wireless shares that Classic owns. This really doesn’t make much sense–but trading in AT&T has gotten so emotional on both the up and down sides that sense is a vanishing commodity here. Just keep an eye on the big picture. The big question for AT&T investors isn’t the revenue shortfall. Rather, it’s whether AT&T’s bet-the-company move into broadband-by-cable wires will succeed. It’s still too early to tell. Should you buy Classic now that it’s been pounded? Or Wireless? Or sell one or both of them? I wish I knew. If I could answer that, I’d be a rich professional investor, not a sore-wristed writer.
