Today Microsoft HR VP Ken DiPietro sent out a message to all employees giving out details of the Stock Option Transfer Program (SOTP). In short, the program will be structured as follows:

- All stock options granted at striking price above $33 and set to expire after February 2004 are eligible
- Employee can choose to sell all or none eligible options to JPMorgan by enrolling in before November 12.
- Final price will be determined by using average closing price for 15 trading days shortly after the election deadline. That's November 17 to December 5 if election deadline does not change.
- Employee can get up to $20,000 upfront by December 2003, and any additional payment will be made in 2 years.
- Proceeds are subject to income tax. Microsoft will withhold income tax for US employees.

Microsoft also supplies a 112-page Notice to Eligible Employees of Stock Option Transfer Program ("Notice") in its intranet web site. In addition, a personalized tool in http://stock offers scenarios of potential cash payments for each employee in different prices.

Interesting Points

- Final price is not made available before the end of the election period because Microsoft wants employees to have the best price. Otherwise to avoid risks JPMorgan can only offer a discounted price.

- As an ancedotal evidence, if the final average price is $28, stock options will be priced as:
1999 Annual Grant (7/30/1999) @ $42.9063 Stock Option Price = $0.76
2000 Catch-Up Grant (4/24/2000) @ 33.3125 Stock Option Price = $2.95
2000 Annual Grant (7/31/2000) @ 34.9063 Stock Option Price = $2.48

- As in the Notice, JPMorgan will sell a significant number of shares to achieve its desired hedge position during the 15-day averaging period (and before and after that period). As the total eligible number of options is 624,000,000 (page 35 of Notice). Microsoft also mentioned that the potential payment for all those options at price $27 will be $919 million. This may suggest that majority of the eligible grant is in 1999 Annual Grant.

- To achieve its desired hedge position, JPMorgan may choose to sell 200m to 400m during the 15-trading-day averaging period. This means a volume of 15-25m shares/day on top of normal volume of 49m shares/day in the last 13 weeks. This will add significant downward pressure to MSFT stock. Therefore, it is prudent to assume that the final average price will be $1.50 less than the closing price for November 12, the last trading day in the election period.

- Between now and the end of the election period, Microsoft will release its Q1 earnings. The Street is expecting EPS of $0.28, or 10+% more than last year. Earnings from INTC and other tech giants suggest good outlook for MSFT. No matter Microsoft meets the target or not, the stock price may be volatile between now and November 12, so it definitely makes more sense to make the election decision closer to November 12.

- On the other hand, MSFT is trading at 27x its FY04 EPS. The valulation may be too rich for Microsoft. Even assume 15% EPS growth in the next three years, achieving break-even point for the election ($33 + $3 = $36) implies then-P/E ratio of 22x. it's hard to imagine MSFT can keep 15% EPS growth with a much larger revenue base then and thus the 20+x P/E ratio. It may suggest it's reasonable to sell those options as MSFT is near its 52-week high now (actually in the top price range since April 2002).

Personal Take

- I'm currently electing to transfer my options as I perceive the current pricing as fair and meaningful. However I'll review my election after the Q1 earning release, and again closer to November 12.
- If I choose to transfer my options, I might have an after-tax income of $5,000. It should help to build a nice cash pile into 2004. No financial actions need to be taken at this moment, though I might need to adjust my W4 withholding status (3 deductions claimed + $350 additional tax withholding/pay period to catch up in income tax) for December. I might also try out some bank promotions to earn some quick dollars.