Millionaires aren’t exactly rare in high-tech land. But this has to be the first time employees have averaged $1 million-plus in option profits at a company the size of Microsoft, which has about 24,000 staffers, about 21,000 of whom have options. And it’s not Bill Gates’s zillions making the average artificially high. Chairman Bill and his second in command, Steven Ballmer, already own so much stock ($38 billion and $8.5 billion, respectively, according to CDA/Investnet) that giving them options would verge on the obscene. So they’re among the optionless.
It’s hard to believe that employees in a big company can average a million bucks of option profits, but here’s the math. Microsoft had 259 million options outstanding as of Sept. 30. The options give holders the right to buy stock at a fixed price during a fixed period. The company says that option holders’ weighted-average price was $41.89 a share. Soto figure the paper profits on the options, take Microsoft’s stock price ($1419/16 on Thanksgiving Eve), subtract the $41.89 exercise price and multiply that difference by 259 million. VoilA! Paper profit: $25.8 billion. Divided by Microsoft’s 23,811 employees: about $1.1 million each. Yes, I know that the Sept. 30 option numbers had changed by Thanksgiving, and I know that many of the options can’t be exercised for years. I haven’t allowed for income taxes on option profits, either. But counting all this money is just so much fun. To me, Microsoft’s creating so much wealth and spreading it so widely is far more impressive than Gates’s megafortune.
Now for the problem–there always is one, isn’t there? Even Microsoft’s $10 billion or so of cash doesn’t begin to cover its whole obligation to option-holding employees. The box above shows how fast this obligation is rising. ““Most of our financial liabilities are in the form of our employeee stock options,’’ Greg Maffei, Microsoft’s chief financial officer, said in an interview.
A motivated work force is Microsoft’s major asset–and there’s nothing like the possibility of millionairehood to get you motivated. But the options that motivate employees dilute the stakes of existing holders. If Microsoft were to issue all 259 million option shares today, existing holders’ stake in the company would drop to about 83 percent from the current 100 percent. This is what’s known as dilution. And dilution tends to be bad for your stock price.
To keep dilution as low as possible, Microsoft buys shares at today’s high price in the market and reissues them at low option prices to employees. Think of it as buying dear and selling cheap, not exactly what Microsoft is known for. This game gets pretty expensive–even though, for reasons we have no time to go into, the cost isn’t charged against Microsoft’s profits. In the three months ended Sept. 30, Microsoft spent $913 million buying its own shares–more than it spent on sales and marketing ($788 million) or research and development ($567 million) or any other single cost item.
Microsoft goes through various contortions to offset some of this cost. My favorite is the company’s selling options giving people the right to sell stock to Microsoft at a fixed price on a fixed day. These ““put’’ options, sold to outsiders, are totally different from the options employees get. The people buying puts are betting that Microsoft’s stock price will fall. The employees with options are betting the price will rise. Through June 30, the company had raised $270 million selling puts that have expired. The company keeps the money tax-free. ““Companies never have to pay tax on transactions involving their stock or options on their stock,’’ says Lehman Brothers tax expert Robert Willens. Microsoft raised an additional $280 million selling puts in its most recent quarter.
So far, spreading options widely has been magic at Microsoft. Their lure keeps salaries low–who cares about salary when you can make a million on options? Non- employees have made fortunes, too. Someday the music will stop, because it always does. But it’s sure fun while it lasts.
PAPER BILLIONS
Watch how Microsoft employees’ paper profits on their stock options have risen even faster than the company’s share price.
STOCK OPTION OPTIONS PROFITS DATE PRICE PRICE (MILLIONS) BILLIONS 6/30/93 $22.00 - $9.03 x 228 = $3.0 6/30/94 25.81 - 11.65 x 228 = 3.2 6/30/95 45.19 - 14.56 x 228 = 7.0 6/30/96 60.06 - 22.07 x 238 = 9.0 6/30/97 126.38 - 31.43 x 239 = 22.7 9/30/97 132.38 - 41.89 x 259 = 23.4
