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The Microsoft Illusion

The problems Microsoft is facing for alleged anti-trust violations just skim the surface of this megacorporation's nefarious financial machinations.

By Bill Parish
Feature Story edited by Chris Petherick

While the world anticipates whether or not Microsoft will be ruled a monopoly, an even greater battle is being waged. This battle is over an attempt to disclose to the American public the facts surrounding an illegal financial pyramid scheme, erected by Microsoft, that is destabilizing public and private retirement systems.

FUNDAMENTAL PROBLEM

The fundamental problem is that Microsoft is incurring massive losses and only by accounting illusions is it able to show a profit. Specifically, Microsoft is granting excessive amounts of stock options that are allowing the company to understate its costs.

You might ask yourself, what would happen to Microsoft's stock price if the public suddenly realized that the firm lost $10 billion in 1999 rather than earning the reported $7.8 billion? If 80 percent of its stock value or roughly $400 billion is the result of a pyramid scheme, one might also ask what kind of effect this could have on the retirement system. It is also important to note that this is a relatively new situation that did not occur before 1995.

Who would believe that the Microsoft Corporation is going to receive a $15 billion deduction on its tax return this year for stock option wages, significantly more than total net income, and that not a dime of this expense is charged to earnings? In addition, more than 75 percent of its massive cash balance has come from these tax deductions in addition to employees prepaying their own wages and speculations on its own stock in the options markets.

Today roughly 4.5 cents of every dollar dedicated to stocks in most public pension plans is going toward the purchase of Microsoft stock. This explains why, at its recent peak, Microsoft's stock represented almost 40 percent of the entire annual federal budget of $1.8 trillion, even though gross annual sales at Micro soft are only $25 billion.

Many other quality companies are now being forced to aggressively adopt similar techniques in order to compete due to a collapse in government policy. These companies will fail because Microsoft has unique advantages.

Microsoft's pyramid scheme, as with all such schemes, is about generating cash. This valuable cash can be used to purchase competitors and establish a beachhead in new industries and further extend the pyramid. A good example is WebMD. Few people realize that Micro soft is WebMD's largest shareholder and that in the last 6 months, while the Department of Justice is focused upon products, WebMD has come to dominate Internet-based health care.

Stock option programs are an excellent benefit and, while many technology firms have such programs, Microsoft has corrupted its own in an effort to generate cash due to its high profits on product sales.

Amazon.com, Yahoo and America On line have similar stock option programs but they are unable to unlock the cash from these deductions because they don't have adequate profits. This is probably one reason why America On line is purchasing Time Warner; that is, to unlock these large unused deductions by offsetting them with profits from Time Warner.

For the quarter ending Dec. 31, 1999 Microsoft also collected cash in the options market of almost $200 million, betting the stock will not decline. If Microsoft guesses wrong and incurs significant losses on the options they will simply issue more stock. There are now more than 6 billion total shares outstanding, meaning that a $1 change in Micro soft's stock price changes the overall market value by $6 billion. Microsoft's gross annual revenues are $25 billion or roughly equivalent to a change in the stock price of $4 per share. Senior citizens may recall this as "watered stock."

Microsoft's internal auditor, a respected Deloitte and Touche accounting veteran, noted in a separate issue that earnings manipulations designed to meet expectations were illegal and constituted fraud. He was given the option to resign or be fired and settled for $4 million under the Federal Whistleblowers Act.

By not disclosing this situation at Microsoft, the Federal Reserve is further destabilizing the economy by raising interest rates since most traditional companies have bank debt and the greater interest expense will affect their reported earnings. Microsoft's debt is stock option debt, and even though leveraged and more than twice annual gross sales, it has no related interest cost. Now that's bad policy for anyone on Main Street.

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Parish & Company is an independent fee based investment advisor to individuals, pensions and trusts based in Portland, Oregon.  No fees are accepted, either directly or indirectly, from any provider of investment products.  Your comments are most appreciated and please do visit my research archive at www.billparish.com.