Financial Statement Analysis & Valuation      Chapter 8 – Microsoft Case     Analysis of Shareholder Equity
BACKGROUND ‘Most successful Software firm ever’ Between 1994 and 2000,    Revenue grew by more than 700%    Earnings g...
QUESTIONS TO TACKLE Cash paid to shareholders Comprehensive Income Issues with Comprehensive Income GAAP Reporting & P...
1. CASH PAID TO SHAREHOLDERSCash Transactions with Shareholders (Amount in Millions)Common Stock Issued                   ...
2. COMPREHENSIVE INCOMEComprehensive IncomeNet Income                           $ 7012.00Other Comprehensive Income Net un...
2. REFORMULATED STATEMENT Beginning Equity                          $ 27,458.00 Transactions with Shareholders  Common sto...
3. COMPREHENSIVE INCOME - ISSUES Comprehensive Income should include Gains or Losses on changes in the value of put warran...
4. EXERCISE OF PUT OPTIONS   GAAP Reporting       Stock Repurchase @ Exercise Price       Loss on put options is not re...
5. REVERSAL OF DILUTION? Can repurchase of shares reverse dilution  arising because of stock option being  exercised? No...
5. REVERSAL OF DILUTION? Are repurchases at share prices of 2000  level, advisable? No.     Duringtech bubble, employee...
6. LOSS TO SHAREHOLDERS     Tax benefit = $ 4.002 billion     Stock Option Loss = $ 4.002/ 0.375 = $ 10.672 billion     ...
TAX BENEFIT AS CFO    Ideally, Stock based compensation and corresponding     tax benefit should be recognized as cash fl...
7. TAX BENEFIT– CORRECT TREATMENT                            USD Billion Tax Payable                  3.612 Tax benefit   ...
8. QUALITY OF REPORTED INCOME       MS pays low tax on a high income           It is recognizing expenses for tax benefi...
9. ISSUES ARISING IN VALUING SHARES   Share repurchases       Is this at fair value or higher prices?   Put warrant lia...
9. VALUATION OF SHARES   MS valuation       Preferred Stock Conversion                                                  ...
10. KNOWLEDGE LIABILITY Outstanding        Wtd. Avg.         Remaining         Black             Overhan Options (mm)     ...
MICROSOFT IN RECENT YEARS Current Stock Price: $26.63          Mkt Cap: $224.5 bn EPS 2000 = 1.35            P/E 1998-2000...
QUESTIONS?
Upcoming SlideShare
Loading in …5
×

Microsoft group 7

487 views

Published on

This is the analysis of the

Published in: Business, Economy & Finance
0 Comments
0 Likes
Statistics
Notes
  • Be the first to comment

  • Be the first to like this

No Downloads
Views
Total views
487
On SlideShare
0
From Embeds
0
Number of Embeds
3
Actions
Shares
0
Downloads
2
Comments
0
Likes
0
Embeds 0
No embeds

No notes for slide

Microsoft group 7

  1. 1. Financial Statement Analysis & Valuation Chapter 8 – Microsoft Case Analysis of Shareholder Equity
  2. 2. BACKGROUND ‘Most successful Software firm ever’ Between 1994 and 2000,  Revenue grew by more than 700%  Earnings grew by more than 1200% Peak of Dotcom Bubble (Between 1998 and 2000):  Stock price rose from $36 to $120 per share  Trailing P/E ratio went as high as 66 Has significant ‘Knowledge Capital’  Stock Options used to attract leading talent  GAAP Accounting does not report this cost nor even significant off-balance sheet liabilities to pay for the knowledge
  3. 3. QUESTIONS TO TACKLE Cash paid to shareholders Comprehensive Income Issues with Comprehensive Income GAAP Reporting & Put Options Reversal of Dilution Loss to shareholders from employees Correct treatment of tax benefit accounting Quality of reported income Issues in valuing shares due to stock options treatment
  4. 4. 1. CASH PAID TO SHAREHOLDERSCash Transactions with Shareholders (Amount in Millions)Common Stock Issued $ 1750Common Stock Repurchased ($4872)Net Cash Paid to Shareholders $ 3122 Working Backwards: Cash Transactions with Shareholders (Amount in Millions) ($ $980 given in Common Stock Repurchased ($ 186.00) 4872) case, $113 difference ($ 4686) Common Stock Issued $ 2843.00 Preferred Stock converted to common stock $ 1093 Net proceeds on issue of common stock $ 1750 Net Cash Paid to Shareholders $ 3122
  5. 5. 2. COMPREHENSIVE INCOMEComprehensive IncomeNet Income $ 7012.00Other Comprehensive Income Net unrealized investment gains $ 2724.00 Translation adjustments and other $ 166.00 Preferred dividends $ (13.00) $ 9889.00
  6. 6. 2. REFORMULATED STATEMENT Beginning Equity $ 27,458.00 Transactions with Shareholders Common stock issued $ 2843.00 Proceeds from sale of put warrants $ 472.00 Tax benefit from stock option exercise $ 4002.00 Common stock repurchased $ (4872.00) $ 2445.00 Comprehensive Income Net Income $ 7012.00 Other Comprehensive Income Net unrealized investment gains $ 2724.00 Translation adjustments and other $ 166.00 Preferred dividends $ (13.00) $ 9889.00 Ending Equity $ 39,792.00
  7. 7. 3. COMPREHENSIVE INCOME - ISSUES Comprehensive Income should include Gains or Losses on changes in the value of put warrants and stock based compensation expense net of tax benefits.  Stock Option loss : Tax benefit = $ 4.002 bn  Stock based compensation expense and related tax benefit would affect the operating income  Option overhang of After tax Stock Option Loss is an off- balance sheet item  Preferred Stock converted to Common Stock  Conversion @ $77 per share whereas market price of $93  Loss on conversion to common stock is recognized in income statement  Sale of put warrants – Stock options are contingent liabilities  Premium should be recognized as liability  Change in valuation of liability (or warrant ) is recorded as loss (gain) in income statement
  8. 8. 4. EXERCISE OF PUT OPTIONS GAAP Reporting  Stock Repurchase @ Exercise Price  Loss on put options is not recognized on balance sheet Clean-Surplus Reporting  Write off corresponding financial obligations  Common Stock Repurchased at market price  Recognize loss in Income Statement (Retained Earnings)
  9. 9. 5. REVERSAL OF DILUTION? Can repurchase of shares reverse dilution arising because of stock option being exercised? No.  Ifrepurchase is at fair value, there is no change in per share value of equity. The share holder doesn’t get extra value to compensate for the loss of value from stock options. Only the number of outstanding shares remains unaffect
  10. 10. 5. REVERSAL OF DILUTION? Are repurchases at share prices of 2000 level, advisable? No.  Duringtech bubble, employees exercised stock options at high prices  Firms had to buy back shares at high prices further increasing the dilution Double hit for remaining shareholders
  11. 11. 6. LOSS TO SHAREHOLDERS  Tax benefit = $ 4.002 billion  Stock Option Loss = $ 4.002/ 0.375 = $ 10.672 billion USD Billion Stock Option Loss 10.672 Tax Benefit @ 37.5% 4.002 Stock Option Loss After-tax 6.67Compensation cost net of tax would be recorded on the income statementover the period between the option grant date and the date the options becomexercisable
  12. 12. TAX BENEFIT AS CFO  Ideally, Stock based compensation and corresponding tax benefit should be recognized as cash flow from operations  GAAP doesn’t recognize Stock based compensation as an expense  And recognizes tax benefit as financing activity  EITF requires tax benefit to be recognized as CFO
  13. 13. 7. TAX BENEFIT– CORRECT TREATMENT USD Billion Tax Payable 3.612 Tax benefit 4.002  Tax ( to be paid ) comes to be negative by this calculation  Microsoft should have recognized the compensation expense in Income statement along with Tax benefit USD Billion Income Reported, before Tax 10.624 Loss on exercise of SOP 10.672 Loss before Tax (.048) Taxes (3.612 – 4.002) (0.390) Net Income 0.342
  14. 14. 8. QUALITY OF REPORTED INCOME  MS pays low tax on a high income  It is recognizing expenses for tax benefit  But the same expense is not carried on its books Quality of earnings is not reliable.Other revenues and expenses might not be accurate either
  15. 15. 9. ISSUES ARISING IN VALUING SHARES Share repurchases  Is this at fair value or higher prices? Put warrant liability  The options are currently out of money  But the exercise date for some was till Dec 2002, and subsequently share price fell drastically.  No liability recorded as put warrants went into money  Nor any loss on these warrants would be recognized when exercised  Valuation of shares should be adjusted accordingly for off- balance sheet liability
  16. 16. 9. VALUATION OF SHARES MS valuation  Preferred Stock Conversion USD Net proceeds from issue of convertible preferred $ 1093 million stock Number of convertible preferred stock issued 12.5 million Price per stock ( preferred ) $ 87.4 Conversion Ratio 1.1273 (common stock ) Price per common stock $ 77 Price Share on Dec 15, 1999 / Book value of preferred $ 93 stock was converted to book value of common stock issued and no loss was recorded
  17. 17. 10. KNOWLEDGE LIABILITY Outstanding Wtd. Avg. Remaining Black Overhan Options (mm) exercise Life Scholes g ($ price ($) Option Value mm) 133 4.57 2.1 75.972 10,104 104 10.89 3 70.908 7,374 135 14.99 3.7 68.009 9,181 96 32.08 4.5 56.079 5,384 198 63.19 7.3 45.495 9,008 166 89.91 8.6 40.781 6,770 832 47,821 Note: Additional values required for Black Scholes calculation as on June 30, 2000: stock price=$80; risk free interest rate=6.2% ; volatility=33%
  18. 18. MICROSOFT IN RECENT YEARS Current Stock Price: $26.63 Mkt Cap: $224.5 bn EPS 2000 = 1.35 P/E 1998-2000 = 66 EPS 2011 = 2.52 P/E 1998-2000 = 10.62 P/E Industry = 18.30
  19. 19. QUESTIONS?

×