Jesse Berst: The coming M$ crash

I'm not a financial analyst. I don't even play one on TV. But I have stumbled on two developments that could cause a crash in Microsoft's stock price.

No, I'm not talking about the antitrust trial. Even if Microsoft loses the first round, it is likely to win on appeal. And I'm not even talking about the ever-present risk of new competition or declining PC sales. Microsoft officials warn of these two threats every quarter... and every quarter the company beats expectations anyway.

I'm talking about two obscure accounting rules that could undermine Microsoft's financial foundations. Before I tell you more, I want you to listen up... don't take my word on these issues. Do your own research. Finance is not my specialty. I don't have the skills to predict what will happen. But I do know a dangerous situation when I see one. And I owe it to you to give you this warning.


The success of high-tech companies is built on stock options. Those options make it possible to attract and retain the best and brightest, since options can turn employees into millionaires in a few short months.

What if those options became so expensive to issue that many companies would be forced to forego them? Especially Microsoft?

The Financial Accounting Standards Board may soon change the rules on options. Right now, companies must report employee salaries and benefits as expenses. But they don't have to do the same with employee options. As a result, companies that make heavy use of options report artificially inflated earnings.

The FASB has tried to fix this problem before... and failed. This time, as Wired Magazine's Michael Noer reported recently, "it looks like effective new rules will be issued. The question is how much impact this will have."

London-based research firm Smithers & Co determined that Microsoft would have lost more than $15bn (£9.3bn) in fiscal 1997 if the new rules had been in effect. (Microsoft reported a $3.4bn profit instead.) Other high-flyers such as Dell and Cisco would have shown losses too.

The new rules could take place as soon as the end of this year. Now I ask you... what would happen to Microsoft's stock if it suddenly reported a massive loss, instead of the profits everyone expects?

Problem number one is bad enough. And problem number two may be even worse for Microsoft's stock price.

Microsoft's stock price will end 1999:

*About the same

*All-time high

*Lower than it has been for years

Isn't it amazing how Microsoft always outperforms expectations? Quarter after quarter, year after year, the company reports results just a little bit higher than analysts' predictions.

Amazing coincidence? Or cunning manipulation? For years, commentator Mark Anderson has warned of Microsoft's "cookie jar" accounting. The president and editor of Strategic News Service, an esteemed insiders newsletter, he claims "Microsoft has so much money socked away that they can produce any financial results they want to..."

Microsoft has used its cash reserves "to make themselves the only sure tech stock bet on the Street", says Anderson. "Would the company's price/earnings ratio be so high without this (artificial?) performance? Probably not."

Concerns about Microsoft's accounting practices have reached the Securities and Exchange Commission, which finally began an investigation this summer. SEC spokesperson Duncan King told The Wall Street Journal that "smoothed earnings don't give an accurate picture of the company, which is what accounting is supposed to do".

So consider this -- what happens if the SEC forces Microsoft to restate its earnings? Even if those new earnings turn out to be higher in some cases, it will cast doubt on the company's integrity -- on the heels of similar suspicions arising from the antitrust trial.

And how would the market react if both things took place before the end of the year?

I want to end by reaffirming that I consider Bill Gates, Steve Ballmer and Bob Herbold the smartest threesome in the high-tech industry. And by saying it's possible neither of these changes will come to pass. But if they do... I'm not sure even Microsoft's sterling record will save its stock from a beating.