Options Buyback a Tough Sell for Some
In its new quest to make profits off “underwater” stock options, Wall Street may be embarking on a fishing expedition.
Microsoft Corp. and J.P. Morgan Chase & Co. made a splash this week with their plan to provide the software giant’s employees with cash for their out-of-the-money stock options, but experts say there is little chance that a large market for such options will develop soon.
Other big technology companies, including Dell Computer Corp., Oracle Corp., Intel Corp. and Cisco Systems Inc., say they still believe in options as a tool for attracting and motivating employees and have no intention of following their rival’s lead in doing away with options awards or cashing out existing options.
For another thing, it remains to be seen how well the options buyout -- assuming it gets the required Securities and Exchange Commission approval -- will fly with Microsoft employees.
With tech stocks on an upswing this year, some employees may want to take their chances with the options they hold, hoping for a surge in Microsoft’s stock price that would make the instruments valuable again.
“The paint is very, very wet on this concept,” said Bruce Brumberg, editor of mystockoptions.com, which provides information on employee stock options and restricted stock.
Still, with few merger-and-acquisition deals afoot, investment bankers are salivating over a potentially lucrative new business.
Neither J.P. Morgan nor Microsoft has provided details on how the buyback would work. But it is understood that Morgan would buy the options at a discount and then hedge its exposure, probably by selling listed Microsoft call options.
Options grant the owner the right to buy a specified number of shares of the underlying stock at a specified price, known as the strike price, during the term of the option. If the stock is selling below the strike price, the option is said to be out of the money or “underwater.”
Instead of options, Microsoft said it would begin granting employees restricted stock, which carries the same value as publicly traded stock but has limits on when it can be sold.
Microsoft’s stock closed Thursday at $26.91, down 56 cents, on the Nasdaq market. That’s $1.39 below where it was five years ago and $32.55 below its all-time closing high of $59.56 in December 1999.
The company has said that most of its 1.6 billion employee options are underwater and that it expects broad participation in the proposed buyout.
Microsoft says its motivation for the buyout plan is twofold: boost employee morale and lower risk.
That may be, but Wall Street’s hopes of creating a lucrative new area for generating business -- and fees -- may be blunted by the recent stock rally. As executives at other tech and biotech firms have watched their shares advance smartly, they contrast that with Microsoft’s anemic stock performance.
“I would note that Microsoft’s stock today is lower than six months ago, lower than a year ago, lower than three years ago and lower than five years ago,” said Genentech Inc. CEO Arthur D. Levinson. “Many companies in our business are not in that situation.”
Since bottoming on March 11, the Nasdaq composite index has jumped almost 35%, while Microsoft has gained about half that much. Microsoft’s stock is up 4% year to date, compared with 23% for Dell, 65% for EBay Inc. and 134% for Genentech.
A rising share price means better options performance. Of Oracle’s 455 million outstanding options, 74% are in the money, partly due to the stock’s 17% gain this year, spokeswoman Deborah Lilienthal said.
Some experts say that by calling restricted stock a better deal for employees, Microsoft is tacitly saying its future stock performance won’t be so hot, either.
Graef Crystal, a compensation consultant and columnist for Bloomberg News, calculated that in order for an options award granted now to outperform an equivalent award of restricted stock, Microsoft’s stock price would have to rise at a 10.8% compounded annual rate -- hardly stratospheric growth for a dominant tech firm.
There’s also the question of fairness, which may make other companies resist overtures from Wall Street firms to take the plunge into options buyouts. Some pundits have groused that the practice would defeat the original purpose of options, which was to reward employees only if their company’s share price rose.
Buying back options “would run completely counter to our pay-for-performance compensation philosophy,” Dell spokesman Mike Maher said.
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Mulligan reported from New York, Pham from Los Angeles. Times staff writer Denise Gellene in Los Angeles contributed to this report.
