I've decided to go over the Discounted Cash Flow models berore traditional cash flow, but before I go on I would like to ensure that everyone onthis thread is aware of the treasures to be found hiddden in the fine print of annual reports.
We will use the money that we found here to add back to cash flows and invested capital.
Out of liabilities comes and into profits and capital goes:
Unearned revenues - they are an accounting term that stuff revenue away for a rainy day (see valuation primer part I) and already represent cash attained, thus they should be added back to profits and capital.
The Other category - non-descript and can be held suspect.
Of worthy note from the Notes at the fine print of the Microsoft 1996 Annual Report:
Principles of consolidation. The financial statements include the accounts of Microsoft and its subsidiaries. Significant intercompany transactions and balances have been eliminated. Investments in 50% owned joint ventures are accounted for using the equity method; the Company's share of joint ventures' operating results is reflected in nonoperating expenses.
Estimates and assumptions. Preparing financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, and expenses. Examples include provisions for returns and bad debts and the length of product life cycles and buildings' lives. Actual results may differ from these estimates.
Foreign currencies. Assets and liabilities recorded in foreign currencies on the books of foreign subsidiaries are translated at the exchange rate on the balance sheet date. Translation adjustments resulting from this process are charged or credited to equity. Revenues, costs, and expenses are translated at average rates of exchange prevailing during the year. Gains and losses on foreign currency transactions are included in nonoperating expenses
Revenue recognition. Revenue attributable to significant support (telephone support and unspecified enhancements such as service packs and Internet browser updates) is recognized ratably over the product's life cycle, which may exceed one year <<Office 97 (office suites comprise the bulk of MSFT's revenue), SQL server, and Windows NT 4.0 are generating significnat revenue during the period in question, think about how much of it falls under this category - can we assume $400 million over 5 years?> Costs related to insignificant obligations, which include telephone support for certain products, are accrued. Provisions are recorded for returns and bad debts. The RCM Financial Group comment - these can be significantly overstated which tends to HIDE MONEY.
Income taxes. Income tax expense includes U.S. and international income taxes, plus an accrual for U.S. taxes on undistributed earnings of international subsidiaries. Certain items of income and expense are not reported in tax returns and financial statements in the same year. The tax effect of this difference is reported as deferred income taxes. An extra $515 million dollars found.
Stock option plans. The Company has stock option plans for directors, officers, and all employees, which provide for nonqualified and incentive stock options. The Board of Directors determines the option price (not to be less than fair market value for incentive options) at the date of grant. Options granted prior to 1995 generally vest over four and one-half years and expire ten years from the date of grant. Options granted during and after 1995 generally vest over four and one-half years and expire seven years from the date of grant, while certain options vest over seven and one-half years and expire after ten years. At June 30, 1996, options for 60.2 million shares were vested and 67.8 million shares were available for future grants under the plans. Balance as of June 30, 1996 = 44.14 million, a significant expense in a buyout situation.
Noncontinuing Items
During 1995, Microsoft paid a $46 million breakup fee to Intuit Inc. in connection with the termination of a planned merger. During 1994, the Company recorded a net pretax charge of $90 million, reflecting the settlement of patent litigation with Stac Electronics. Add back $136 million to normalized cash flows, unless history shoes this to be a regular occurence, for conservatisms sake, we shall omit it.
Commitments and Contingencies
The Company has operating leases for most U.S. and international sales and support offices and certain equipment. Rental expense for operating leases was $68 million, $86 million, and $92 million in 1994, 1995, and 1996. Future minimum rental commitments under noncancelable leases, in millions of dollars, are: 1997, $89; 1998, $76; 1999, $58; 2000, $28; 2001, $24; and thereafter, $19.
In connection with the Company's communication infrastructure and the operation of The Microsoft Network, Microsoft has certain communication usage commitments. Future related minimum commitments, in millions of dollars, are: 1997, $65; 1998, $78; 1999, $106; 2000, $80; and 2001, $11. Also, Microsoft has committed to certain volumes of outsourced manufacturing of packaged product in the United States and has committed $293 million for constructing new buildings. (See Valuation Primer Part I on treatment of multiyear R&D investments as opposed to expenses).
During 1996, Microsoft and National Broadcasting Company (NBC) established two MSNBC joint ventures: a 24-hour cable news and information channel and an interactive online news service. Microsoft agreed to pay $220 million over a five-year period for its interest in the cable venture and to pay one-half of operational funding of both joint ventures for a multiyear period. (See Valuation Primer Part I on treatment of multiyear R&D investments as opposed to expenses).
Microsoft is subject to various legal proceedings and claims that arise in the ordinary course of business. Management currently believes that resolving these matters will not have a material adverse impact on the Company's financial position or its results of operations.
Now, as you can see; by looking carefully we found nearly ONE billion dollars of money that the average investor (the ones who do not have New Media Financial knowledge products - cheap plug there, but accurate) would have overlooked. One billion dollars is about five times what NSCP, MSFT's Internet nemesis, currently has in the bank. It is surprising what you can find when you use New Media Financial Knowledgeware (another one) and a little work.
Next: discounted cash flow, EVA and MVA: all incorporating the money we just found under the matress here... |
