the issue
Yesterday, MSFT announced it was selling, in a private (not registered with the SEC) offering, $1.15 billion in senior convertible notes, due (at a time not specified in the press release) in 2013. The offering has the following terms:
–the notes are being sold at face value
–MSFT will pay no interest
—the notes are convertible into MSFT stock at a price of $33.40 per share, a 33% premium to yesterday’s close
–under normal circumstances, the conversion feature can’t be used until March 15, 2013.
why do this?
a MSFT perspective
MSFT, a company I owned for more than a decade and have followed for over 20 years, is admittedly a quirky company. But I can’t imagine that the idea for this deal originated with the firm.
As of the most recent 10-Q, MSFT has almost $40 billion in cash on the balance sheet. It’s generating over $15 billion annually in free cash flow.
Yes, MSFT did try to buy YHOO for about $40 billion a few years ago, but thought better of it when YHOO was subsequently offered to it on a platter at about half that price. MSFT seems to me much more careful with its money these days, so I don’t think a big acquisition is in the cards. But even if it were, $1.15 billion–what the company earns every three weeks–would be just a drop in the bucket. If motivated by the idea of a large purchase, the offer should have been a lot bigger.
I think MSFT sees the deal as free money, the equivalent of picking up a $100 bill you see on the sidewalk.
the buyer
My guess is that the buyer, whose name has not yet been disclosed–and who may remain anonymous–approached MSFT. In all likelihood, it’s a professional investor who has contracts with some clients that require it hold only fixed income instruments for them. The holder forgoes a relatively small amount of interest income in return for the chance at a large capital gain if MSFT stock goes up more than 10% annually for the next three years.
To state the obvious, the buyer must:
–be very bullish about MSFT’s prospects, and/or
–think stocks will do relatively well and MSFT is a comfortable proxy for the S&P as a whole, and/or
–think making money from bonds will be hard over the next few years.
For its part, MSFT continues to buy back its own stock. It will also try to offset potential dilution from the note offering through options.
oddity or harbinger?
It’s too soon to tell. But I think it’s something to keep an eye on, as a potential source of support for stocks in general, and for bond-like stocks in the MSFT mold in particular.
why not pick up the same stocks in the open market? obviously i still do not get it.
Thanks for your comment. As you suggest, this transaction doesn’t make a lot of sense. That’s what makes it so interesting.
I think the buyer must be an investor with a fixed income mandate, or at least a fixed income orientation. If the buyer manages, say, pension money for others, he will have a contract that spells out explicitly what securities he is allowed to buy. That won’t include stocks. So if he wants to get equity exposure, the only way he can do it is through a convertible.
As a practical matter, if he sees any way to make good money by buying bonds, he wouldn’t be foolish enough to stray from what he knows best.
The fact that he has suggests that he thinks it will be tough making money in the bond market from here on in. I happen to think he’s right, but it’s nice to have some confirmation from the bond world itself.
Looked at another way, if he invested the $1.15 billion in three-year treasuries, he would get a little more than 1% per year in interest income. That’s not much. He’s giving that up in return for what amounts to an option to buy MSFT stock at $33.40 a share. To him at least, the option is worth that. From a common sense point of view, he thinks a 30%+ gain in MSFT stock over three years is at least possible.
Why MSFT? It’s a very bond-like stock. The plusses are that business is looking up for the first time in about a decade and that a rising stock market will likely at least drag MSFT along with it. The negatives: top management hasn’t really distinguished itself and change of control is unlikely.
I think it will be interesting to see if other deals like this one surface.