Harvey,
Here is a nice bit from today's New York Times.
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By GRETCHEN MORGENSON
Now that the government has formally proposed a break up of Microsoft, some investors may expect its depressed shares to rebound, simply because the company's worst fate is clear.
If the shares recover, though, they will have to do so with one of the biggest buyers of Microsoft shares stuck on the market's sidelines: Microsoft itself.
In a television interview Tuesday, Bill Gates declined to say whether the company was buying shares at current bargain prices. The fact is, it cannot.
That is because of its $1.5 billion purchase last January of Visio, a maker of diagramming software. The deal used Microsoft stock in a pooling of interests transaction. Its structure makes Microsoft's earnings look better than they would if the acquisition were accounted for differently.
But the benfit of pooling has a cost. Under accounting rules, a company making such an acquisition cannot buy back shares immediately after the deal. Microsoft's hands are tied until June 7.
That shuts down a big bidder. Trying to mitigate the dilution to earnings that its enormous employee stock option program represents, it has bought back 764 million shares since 1990. In the six months ending last Dec. 31, Microsoft bought back $4. billion of its stock.
Microsoft's absence from the market this year helps explain why the shares have behaved so dismally. It closed the week at $69.75, down 11.6 percent.
The company will likely come roaring back into the market June 8. Meanwhile, investors get a glimpse of what can happen when a firm which has benefitted mightily from a rising stock price sees its shares decline.
For years, Microsoft stock climbed on the strength of enviable profits. One reason for the profitability was its reliance on stock options, which cut costs while keeping workers happy and rich.
The rising stock also meant that few shareholders groused about the dilution to earnings presented by the 1.1 billion shares Microsoft says it has issued since 1990, net of buybacks, under stock option and purchase plans.
Now Wall Street frets that Microsoft's profit growth is waning. Coupled with the breakup threat, the stock has crumbled. And the equation changes.
Employees, whose options from previous years are now under
water, become restless. To keep them happy, Microsoft last week awarded 70 million new stock options at $66.625 each. The indicated value of the grant: $1.9 billion.
But no longer seeing automatic profits in the stock, some
Microsoft investors may start to care about earnings dilution. With Microsoft unable to buy back shares for six months, the true impact of options on the company -- they are IOU's to be paid off by shareholders -- becomes more evident.
Even if the company stopped issuing options, a stagnant stock could further dilute earnings. For years, Microsoft has made bets with investors that its stock would not decline. Under these arrangements, called put warrants, if the stock trades at a specified price when they expire -- between $69 and $78 per share -- Microsoft must pay the holders an amount equal to that price multiplied by the number of shares the warrants cover. Such transactions are typically completed using cash, but Microsoft has positioned itself to close out the trades with shares, if it wishes.
As the stock rose, the warrants generated easy money that
Microsoft used to defray the cost of stock buybacks. In the six months ending Dec. 31, warrants generated $472 million.
Its shares skidding, Microsoft may soon be on the hook to
investors on the other side of the bets. According to company filings, 163 million shares are covered by put warrants that begin to expire in June. The company would not say how many warrants expire then, but if any expire in the money, and if Microsoft pays in stock, earnings will be further diluted.
And as the bets become costlier, the company may no longer
want to make them, eliminating a source of cash used to buy
back shares and stem dilution.
Microsoft has made much hay while the sun shone. Now it is
finding that when it rains, it pours.
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Hey, how about that campers! McSoftee is melting.
Thure |
