Tuesday, August 29, 2006

Transparency? Well, it ain't AERO Glass, that's for sure.

Continuing my recent theme of whether we're seeing performance for the massive collective compensation we're underwriting at MSFT (much to the dismay of several employees, apparently, based on their subsequent comments), I did some research to see what payout MSFT finally decided on with respect to the Shared Performance Stock Awards (SPSA's).

For those who don't recall, in 2004, MSFT instituted the SPSA program as "a long-term incentive program for executives and other senior leaders that makes a significant portion of their stock-based compensation dependent upon the company's growth and customer satisfaction over a three-year period." This group was comprised of the so-called "top 500" executives (now magically morphed to at least 600 given the rabbit-like nature of MSFT's headcount multiplication) or effectively the supposed top brain trust of the entire company. To the best of my knowledge, the actual metrics were never publicly disclosed beyond that vague "company growth and customer satisfaction" drivel. Some of that makes sense competitively, but having virtually all of it be secret doesn't, and makes it impossible to independently verify subsequent performance against those objectives.

The payout amount was to "be determined by adjusting upward or downward from the target in a range between 33% and 150%". The target, by the way, was set at 31.7M shares. So where did it end up? Turns out, that's easier asked than answered. In reviewing the recent 10-K which you can find here, we see the following:

The performance period for SPSAs issued in fiscal years 2004, 2005, and 2006 was July 1, 2003 through June 30, 2006 (January 1, 2004 through June 30, 2006 for certain executive officers). Following the end of the performance period, the Board of Directors determined that the number of shares of stock awards to be issued was 37.0 million, based on the actual performance against metrics established for the performance period.

This seems to answer what the final amount was: 37M shares versus the original target of 31.7M - an increase of ~17%. So was the final sliding-scale payout %, arrived at by the board of directors and based on performance against these publicly unavailable (and therefore unverifiable) metrics, 117%? Good question. Of course, since I pointed out that the "top 500" has likely morphed to at least 600, maybe that bumped up the actual versus the target? That could be consistent with rumors that the final payout % was 101%. But wait, MSFT is committed to transparency, right? So there's no way they wouldn't tell shareholders what payout % they finally arrived at on these singularly important metrics, for these critical employees, and given the significant $ involved (~$1B), correct? Well, not surprisingly, I couldn't find that articulation in plain English anywhere. So I fired up my email and put the question to MSFT Investor Relations. Here's their response (which, I should point out, was at least timely, as usual):

While we do not disclose the percentage for the SPSAs, you can view the number of shares to be issued under the recently completed SPSA performance period in our Form 10K filing on our Investor Relations website at Below is an excerpt from the 2006 10K filing, which discloses that information.

In other words, the % is none of my business - or yours, for that matter. Why is that? What could possibly be jeopardized by telling us that, for example, the payout was 90% or 102.3%? There doesn't seem to be any obvious operational or competitive explanation for withholding that info - especially given the company's commitment to transparency (cough, sputter, wink). And clearly, as a shareholder, it would be nice to have some relative feeling for how the management team assesses its own performance over the past 3 years. But there is a pretty obvious political explanation - a management team giving themselves 100%+ bonuses during a time period when the company was plagued by product delays, delivered its worst YOY growth rate in its history as a public company, and badly lagged every major market index (to name only a partial list), isn't great optics or likely to sit well with frustrated shareholders - or potential investors.

Oh, and in the MSFT spirit of arguing that one approach provides better alignment with shareholders, only to later change it and argue the reverse, the new SPSA program will be yearly not every 3 years:

The Company will grant SPSAs for fiscal year 2007 with a performance period of July 1, 2006 through June 30, 2007.

So does that mean that executives no longer need "longer-term incentives", or that long-term "company growth and customer satisfaction" are no longer goals? I'm sure that by the time the shareholder meeting rolls around, management will tell us how the new and improved 1 year term "better aligns executives with shareholders" - just like the move from 1 to 3 years was meant to do, or the move to grants from options, etc. etc. etc. Not sure about you, but every time I hear MSFT say that they're making compensation changes to better align with my needs, I know that of all the possible outcomes, that particular one is the least likely.

Monday, August 28, 2006

Pay for performance or performance for pay?

I'm a big fan of Mini-MSFT and therefore check out his site fairly frequently. I encourage other shareholders to do likewise. The other day, he linked to a post which failed to make his cut but caught my attention nevertheless. You can find it here. It's from a rather irate MSFT shareholder (are there any other kind?) and the author didn't hold back on what he saw as employee whining - which perhaps explains why he/she ended up on Mini's cutting room floor. But one of the more valid points was this one: the work to make customers and stockholders happy and we'll reward you by increasing your stock price. it'll pay off in espp AND your stock awards.

Mini's comment on the [entire] post was as follows:

Chicken, egg, vicious cycle and motivating benefits. How does it all come together? Don't you have to have stock to be motivated to raise it? And don't you first need to be motivated to buy / acquire stock?)

I think that's a good question, and one I'll return to shortly. Meanwhile, several other comments in the latest Mini thread (which didn't get cut) also speak to this general topic of employee vs shareholder rewards. The most concerning one being this:

I really don't care about the shareholders. Their goals and mine are no longer aligned. My goal is to get promoted, increase my pay and get as many stock awards as possible (I dump these as soon as they vest).

Now, of course, this might have been an ABM troll versus an actual employee (Yes Dorothy, we're not in Kansas anymore), and let's hope so, since the alternative it to believe that MSFT hired such a dumbass and, in turn, several other dumbasses are on the payroll who hired him/her. But wait, it gets worse. A later response (same moron perhaps?) reads :

Employees asking for "fair" compensation has nothing to do with shareholders. Shareholders would like it if everyone worked for free. Shareholders are not being forced to hold MSFT stock at gun point.

Employee compensation has "nothing to do with shareholders"? Hey genius, who do you think underwrites those costs via lower earnings and a depressed stock price? I also take issue with the comment that shareholders "would like it if everyone worked for free". Over the past 5 years, in addition to one of the highest aggregate compensation costs in the industry, shareholders have underwritten literally $10B's in additional employee-related costs. These started with additional options grants in 2000, followed by across-the-board salary increases [note: could only find one link but there have been several iterations and company-wide], the multi-billion dollar options trade-in program, the move to grants (which just happened to be accompanied by the extremely favorable restatement of previous financials), and the recent perks - to name but a few. Along the way, the company did cut some benefits, including the infamous towels, in a bid to save $1B in expenses - a move that was roundly criticized. And, in fairness, there are also those who contend that even current salaries still lag the industry. However, the fact remains that billions in additional employee compensation costs have been underwritten by shareholders during a time period where they've seen the value of their investment decrease by over 50%.

Which brings me back to Mini's chicken vs egg scenario. Which is it: is MSFT not performing because employees aren't being paid enough, or have the payments been made but the performance not been forthcoming? As you might have gathered - especially if you cheated and read my comment to Mini about this post - I tend to come down on the side of the latter, but then I look at it from a macro perspective vs individually. I'm sure that not all employees are being well-compensated - particularly low to mid-level ones - but overall compensation is as high as anyone. I also appreciate that the market doesn't always do a good job of reflecting inherent value and that it only makes sense during those periods to keep compensating employees to keep morale high and increase the chances of long-term success. But how much and how long is enough? This has been going on for 5 freakin years now. In fact, MSFT's stock is flat since 1998. Imagine owning a coffee shop (or xyz other business) that hasn't earned you a penny since 1998, despite you underwriting the hiring of tons more staff, the payment of decent salaries to most and outrageous ones to management, AND numerous expensive steps during that time to either increase or stabilize employee compensation. Worse, each successive change and related charge was sold by management as a move to "better align" employees with your needs. How receptive would you be at this point to employee requests for still further compensation in order to show you a return? At what point would you just fire your existing management team and hire a new one instead, cut your operating costs by dramatically pruning headcount, or simply sell your underperforming coffee shop? This is, after all, meant to be a win:win situation - not one one where employees win but owners lose. Again, in fairness, some employees seem to get this (from Mini's thread comments again):

I am starting to get depressed reading the stream of comments. To the outside world I am afraid (I had a few friends read the comments before writing this) we are looking like spoilt brats who only care about compensation. I know it is that time of the year when we find out what our rewards are for the work we did all year. But before you post, please try to think about a shareholder who bought the shares of the company in early 2000 or 2001. We have not delivered anything - nada to these folks. And some of them are nowhere as young or well off as most MSFT employees.

I also think MSFT senior management should take some responsibility for their abysmal performance rather than expect shareholders to bend over further, and redirect some of the massive compensation this largely underperforming group is receiving and distribute it more fairly across the majority of employees. For example, should Jim Allchin, the guy ultimately tasked with getting Vista out the door, have been able to vest some $40M+ of stock over the past year alone, despite overseeing the biggest screw-up in MSFT history? Would that money have been better invested across general employees who, in addition to being more motivated, might actually have had enough confidence in the company's future to hold those shares vs sell them? Or how about the rumor that they've just awarded their 600-odd top managers 101% on their SPSA awards for their performance over the past 3 years - a period that saw the company notch its slowest growth year ever, fail to deliver Vista, grossly underperform every major market index, and execute at a level that made management generally look like the Keystone cops? Now admittedly, the company has grown revenue - and to a much lesser degree earnings - during that period. So some bonus was in order. But how can you possibly defend a 100%+ bonus when you failed so miserably to reward owners? And if there's effectively no penalty for failure in that regard, what's the incentive to avoid continuing to underperform in the future? Bottom line, I think the days of "pay me more and I'll perform" are over. At this point, MSFT needs to demonstrate that what it's already collectively paying is justified, despite most operating - and all market - evidence to the contrary.

Friday, August 18, 2006

What if you held an auction, and no one came?

That appears to be what happened to MSFT - well, mostly. In case you haven't heard, MSFT was unable to secure anywhere near the number of shares that they had hoped to through the Dutch auction. As a result, they'll be putting the remaining money into a larger buyback pool:

First, a mea culpa. I speculated previously that MSFT would have done their homework to ensure that the requisite number of shares could be secured - rather than look foolish. Apparently, I was wrong. As such, I further anticipated that the stock would drop on completion of the tender - but it's gone up now that the tender failed. The theory, supposedly, is that MSFT will be forced to buy the remaining shares on the open market (and quickly) in order to still make their revised EPS guidance for the year. I guess that's possible, although I really don't think MSFT would have any qualms about simply ratcheting guidance back down in the wake of the failed tender. BTW, for market manipulation theorists, take a look at yesterday's intraday action:

I guess that was just a coincidence? :-) Needless to say, the MSFT market maker in New York will be getting his bonus this month - and of course a few recently-ex MSFT shareholders won't be feeling too happy about their choice.

So what now? Personally, I see the Dutch auction as having been a manipulation plain and simple. Long-term best interests of shareholders would have been served by MSFT acquiring the most shares at the lowest price. That was already a suspect result of the auction (see my previous post on that topic), and clearly won't happen now that it has failed to secure the desired shares and the stock has been bumped still higher as a result. So the auction seems to have served no particular purpose other than to goose the stock price short-term - and management denies even being focused on the stock versus trying to manipulate it day to day. Um...right. Don't get me wrong, as stated, if the choice is between hoarding excessive levels of cash versus buying back shares, I'm all for share buybacks. I'd simply prefer that those buybacks be about reducing shares outstanding and not manipulating short-term prices., who I generally respect, sees it differently:

When Microsoft made the Dutch Auction announcement, its stock was at $22.85. The fact that only 155 million shares were tendered, when Microsoft was willing to pay between $22.50 and $24.75 per share, stands out really as a vote of confidence that investors believe greater upside lies ahead for the stock. Additionally, the Board's willingness to commit the $16.2 billion to the traditional repurchase program sends a strong signal that it sees plenty of value in the stock as well.

Critics no doubt will decry the buyback news as being a sign of Microsoft's poor growth prospects. It makes sense, though, for Microsoft to do this because (a) any large acquisition it might consider will bring down antitrust heat and (b) it has the capability to do it with its tremendous cash flow. Rather than leaving shareholders' cash in the bank, Microsoft is doing the right thing in returning it to them with the buyback, not to mention through increased dividend payments.

I agree that the tender result suggests that most shareholders see greater upside than $24.75 (Duh!), though I'm not sure I'd call that a "vote of confidence" per se - it's more like a refusal to capitulate. I'm also not sure that the buyback says much about the Board's assessment of value. They might believe that there's "plenty of value", or they may simply recognize that given the stock's miserable performance and ongoing massive dilution via insider compensation, they can either keep hoarding excessive cash, further dilute the stock, and risk getting thrown out by shareholders (along with the management team), or do buybacks. And of course there were alternatives to the Dutch auction including increasing the regular buyback - like say when the stock was back in the low $20's. Bottom line, to the extent that the buybacks are real, immediate and/or front-end loaded, I'm prepared to accept that the Board and management might see value. But buybacks on extended timelines that get totally erased by ongoing dilution (like most of the $50B+ over the past 5 years), or failed auction stunts, don't say much at all - well, that's positive at least. Oh, and some insider buying - versus leading the entire market in insider selling - might also demonstrate that the "we see tremendous value" party line is more than simply lip-service.

Wednesday, August 16, 2006

Fidelity pulls the plug on MSFT

In case you were wondering why the stock tanked so badly after what MSFT CFO Chris Liddell called last quarter's "disconnect", a big part of it may have been that Fidelity - one of the largest institutional holders in the US - unloaded a whopping 43% of their entire position. Another large holder who apparently decided that pleas for 12-18 months of additional patience (following 3 successive years of massive market underperformance) didn't cut it, was Wellington Management, who decreased their holdings by 31%. Even Goldman Sachs, employer of perpetual MSFT-bull and chief Wall Street apologist [analyst] Rick Sherlund (who has been consistently wrong for going on 3 years now, but amazingly still has a job), lightened their position by 12%. See the info here and note that it's as of June (latest):

It's never a good thing (or vote of confidence in the leadership team) when your heretofore 3rd largest institutional holder decides to unwind 40%+ of their position in a single quarter. Perhaps this explains why management finally decided to get serious about reducing the share count (as several institutional investors were calling for) versus just pretending to (i.e. the last 5 years of buybacks which, for the most part, have been eaten up by ongoing dilution). It also sheds some light on this line from the current tender document:

The Tender Offer provides shareholders (particularly those who, because of the size of their shareholdings, might not be able to sell their shares without potential disruption to the share price) with an opportunity to obtain liquidity with respect to all or a portion of their shares, without potential disruption to the share price and the usual transaction costs associated with market sales.

Now, while you and I might view our holdings as substantial, let's not kid ourselves that selling them would materially impact the price of a stock that trades an average 73M shares per day. So the translation here is: if you're Fidelity (or some other like-minded large holder), please don't dump the stock on the open market and tank the price like you did last quarter - just sell it back to us instead.

Let's see if I'm following this... Management has done such a ridiculously poor job of executing and driving the stock over the past 3 years, that major investors want to dump their position. So rather than address the reasons that investors are fleeing, company leadership (who supposedly aren't focused on the stock at all, far less its short-term direction) will use our money [company cash] to buy out the largest squeaky wheels in the hopes that that will avoid, at least temporarily, the stock falling further? Here's an alternate idea: why don't we save our cash, throw out the underperforming management team, and replace them with folks who can execute such that large investors not only keep holding, but - gasp - actually want to buy more MSFT?

Now, like anything, there's a silver lining. Assuming that MSFT ever gets its act back together (I know, big "if"), then these major folks who are dumping now (and in many cases at historical lows for holding MSFT as a result), may be encouraged to buy back in - thereby providing additional fuel for any subsequent upside move. And of course, there are at least some individuals with strong track records who see opportunity where others seemingly don't:

That's somewhat encouraging, although it's not going to do much short-term, where MSFT continues to do nothing while the market rallies strongly. And if you're hoping that MSFT's plunge-protection team is going to be out in force to defend the stock following the tender's close on August 17th, think again - at least for ten days:

However, Rule 13e-4(f) under the Exchange Act prohibits us from purchasing any shares, other than in the Tender Offer, until at least 10 business days after the Expiration Time. Accordingly, any additional purchases outside the Tender Offer may not be consummated until at least 10 business days after the Expiration Time.

Oh, and who's one of the two "Dealer Managers" for the tender? Why Goldman Sachs of course. So expect to see Sherlund out defending the stock if it takes a substantial dip in the days ahead...

Monday, August 14, 2006

Microsoft's first Live killer app?

Interesting blog posting today by Phil Wainewright @ ZDNet:

He's blown away by the functionality of Microsoft's new Windows Live Writer:

The possibilities are endless — which is exactly what you want from a killer app. I think Microsoft has let the genie out of the bottle with this one.

As a newbie blogger, I thought perhaps I was the only one who thought that the editing tools on sites like Blogger sucked the big one. I can't recall how many times I ended up publishing a post, only to have to go back later and fix formatting mistakes that weren't obvious in the compose mode view. Apparently, I wasn't alone.

As fate would have it, I had already downloaded the Live Writer to see if it was an improvement. So far, I'd say it's a HUGE one and a major time saver. And yes, I used it to post this entry!

An overview of the functionality can be found here:

Kudos to the Microsoft team responsible!

Friday, August 11, 2006

Something Rotten in the State of Denmark?

I promised to look into the $20B modified Dutch auction buyback recently announced by MSFT, before commenting further. Since that time, I've reviewed several articles which discussed the mechanics of the upcoming auction including:

Opinions run the gamut from:

The Dutch auction was surprising and certainly welcome.


But for shareholders seeking an exit strategy after years of stagnant stock prices, it's a chance to reboot.

Unfortunately, none of the articles speculate on why MSFT chose this particular vehicle for doing the buyback. Additionally, I've seen a lot of shareholder confusion on various message boards, including folks [incorrectly] stating that if you don't respond to the tender, MSFT will sell your shares [they can't/won't]. Supposedly, all shareholders of record received an information package from MSFT, but I hadn't, nor could I find it easily on MSFT's main IR page or even under the "stock info" sub-heading. Indeed, I ended up having to contact IR by email, who then notified me that the document could be found under "SEC filings" - where it can be, albeit that the title is cryptic. Another theme expressed by shareholders on several boards was that the tender "puts a cap on MSFT" until August 17th (the tender close date). Frankly, I don't see how that's the case. If anything, the auction puts a floor under MSFT by providing a minimum bid. Nothing prevents MSFT stock from going above the $24.75 upper threshold - except the lack of buying interest that we've seen for 3 years and especially this past one.

So back to "why did MSFT choose this option?". I'm not sure. MSFT says that they're not focused on the stock short-term and instead are focused on long-term returns. Using those criteria, the best interests of shareholders are served by MSFT retiring the maximum amount of shares at the lowest possible price. However, the auction's immediate impact was to make the stock jump, raising a question mark about whether it will even get filled given the [now] modest premium to market. MSFT could have simply announced a further $20B buyback and then executed it more aggressively than folks might have expected. That would seemingly have avoided the pop and given MSFT the chance to buyback more shares, cheaper. Perhaps the concern was transparency and wanting to avoid surprising analysts (well, at least not again given the most recent $60B "disconnect"). Alternatively, maybe the answer is that MSFT didn't want to be in the market every day for an extended period (to complete the buyback without running up the stock). But that one is pretty weak given that MSFT has been in the market doing massive buybacks for some time and the stock has only continued to fall. Meanwhile, Gates - who had atypically missed his normal selling this past quarter - is back to dumping large amounts of shares in advance of the tender. He's joined by others such as H&E honcho Robbie Bach. Both continue to hold considerable amounts of stock, but it still seems interesting that they'd be unloading at this time. It kind of negates the company message that "management wouldn't be participating in the tender", which was meant to indicate bullishness. No, they'll just sell outside of it and at prices below the upper range, instead.

Bottom line, I think the auction was aimed at putting a floor under the stock and to appease institutional shareholders by doing a large (though not as large as was generally desired) immediate buyback. While it's welcome, and (if successful) will help reduce the bloated float of the company following several stupid splits (especially the last one), it really changes very little. Buybacks today are simply MSFT's way of manipulating earnings to try and make them appear better than they are and telegraph bullishness to an increasingly skeptical and bearish market. Real earnings growth will still be relatively flat; emerging businesses will still be losing tons of cash; the company will still be visibly hitting on only half its cylinders. So, unless the market is in rally mode following August 17th, I would expect the stock to drop once the tender closes and that floor is removed. It will also be interesting to see whether the tender gets filled. I suspect MSFT did its homework and that it will. Otherwise, they're going to look foolish and have to do something else. But after all these manipulations are done, it'll be back to the same old question: can management accelerate real business earnings and if so, when? My guess: '08 at the earliest. Given that it was meant to be '03, '04, '05, '06, there should be no surprise if many investors conclude that '08 will become '09, 2010, etc. and/or that the continued wait just isn't worth it.

Tuesday, August 08, 2006

IPTV potential?

As mentioned in my post about the recent Financial Analysts Meeting (FAM), one of the biggest concerns with MSFT's various "big bets" - beyond the massive current losses, of course - is what the magnitude of the eventual payoff might be even assuming success. That's because while MSFT often reiterates its confidence that it's "making the right bets" or "in the right emerging markets", they never bother to articulate for investors what that potential might look like - despite in some cases having racked up losses of over $5B. Which brings me to this article, which I found informative because it does exactly that, at least at a market level, for one of MSFT's longest-term "big bets": IPTV (Internet Protocol Television):

Interesting items from the article include this chart and related commentary:

Global IPTV subscribers will grow to slightly more than 63 million in 2010, rising at a stunning compound annual growth rate (CAGR) of 92.1% from 2.4 million in 2005, noted the firm. The IPTV subscriber base will generate more than US$27 billion in overall IPTV services revenue in 2010. While video services will account for the largest portion of these dollars, value-added media services and IPTV operator advertising will combine to represent more than 14% of IPTV services revenue in 2010. Furthermore, across all IPTV services, the corresponding content licensing revenue will reach US$11 billion in 2010.

Those are some serious numbers and go a long way to explaining why MSFT cares about this market. Indeed, I'm left scratching my head wondering why MSFT wouldn't have included ANY of this macro-level detail at the recent FAM? Of course, as MSFT investors, what we don't know is what the company feels it could make per subscriber. Is it $1? $5? $100? Per month? Per year? And what's the timeframe? 1 year? 3 years? Another 10 years? What we do know is that trials are underway at AT&T, BellSouth, Bell Canada, Deutsche Telecom, British Telecom, Telecomm Italia, Swisscom, Reliance and Telecom South Africa. That's a pretty impressive list and hopefully bodes well for future success - whatever that might be.

I guess my parting comment is "Does is really have to be this hard?". Is it really too much to ask that MSFT share directly - albeit at a high level - macro data like this, along with some idea of the magnitude and timing of the specific payoff? To date, the answer is apparently "yes". And then Ballmer wonders why he's losing credibility and why the judgement of himself and his extended senior management team is increasingly being questioned. Go figure.