Tag Archives: MSFT

MSFT is issuing an unusual convertible

June 9, 2010 By in Convertibles, Current Market Thoughts, Industry Analysis, Investment firms, Recent Market Action, Stock ideas, Technology Tags: , , , , , , , 2 Comments

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.

tax rate, earnings per share, dividends and cash…: (II)

April 28, 2010 By in Current Market Thoughts, emerging markets, Industry Analysis, internet, Stock ideas, Technology, Wireless Tags: , , , , , , , , , , , , , , 1 Comment

lots of cash

A few days ago the Financial Times ran an article pointing out the huge amounts of cash that IT companies have been piling up over the past year.  According to the newspaper, the top ten public firms in technology have added $65 billion to their cash holdings since the market bottom last March.  Together they have about a quarter-trillion dollars on their balance sheets.  The FT points to the lack of anticipated merger and acquisition activity (anti-trust?) as one reason for the accumulation, and suggests that the industry will soon begin to buy back shares to reduce the size of their holdings.

Not all the big ten are as flush as the FT makes them seem, however.  EMC, IBM and ORCL have long-term debt that pretty much offsets the cash they have.  DELL, and to a lesser extent, AMZN, are negative working capital companies.  That is, they collect money from their customers before they have to pay their suppliers.  So they enjoy a kind of “float,” the same way that a restaurant or a hotel does.  There is at least some risk to the cash that appears on the balance sheet for this reason.  If the business slows, the cash begins to disappear as suppliers are paid.

Nevertheless, there are a number of tech firms with staggering amounts of cash and little or no debt.  They include:  AAPL, GOOG, INTC, MSFT and QCOM.

an important question:  where is the money?

As I suggested in yesterday’s post, at least some of the cash is overseas.  How much, no outside observer knows.

Oddly, as I was researching the 2004 amnesty that allowed firms to repatriate money to the US without paying much tax, I found an article that suggests that six years ago, some of the companies themselves, despite their financial control software, didn’t know where the money was, either.  And some had to postpone repatriation while they upgraded their treasury departments to create a mechanism to start the process and handle the incoming money.

Would companies like another amnesty?  An academic study that I also cited yesterday suggests they would.  Professors from Duke, Michigan and Washington conducted an internet survey on this topic.  Two-thirds of respondents said they would like a repeat of the 2004 amnesty.  The median amount anticipated to be repatriated was half of current foreign cash holdings.  Most of the money sent to headquarters would come from cash balances, though some would come from added foreign borrowing. (In the next few days, I’ll post on the limits to the confidence one can have in surveying in today’s world, and in internet surveying in particular.)

Other academic research suggests that the requirement to pay income tax on repatriated earnings does motivate companies to keep large foreign balances, and even to invest the funds in projects that will not be as lucrative as competing investments in the US.

stock buybacks

I’m not a big fan.  Maybe it’s age, but I’d prefer dividend increases.  It may be more tax efficient to buy back stock.  My objection, though, is I think every company has a compensation plan that features a policy of shifting a set percentage, say, 1% a year (but a lot more for small, fast-growing firms), of the ownership of the enterprise away from its shareholders and to its management.  I’m not sure the ordinary shareholder realizes this.  And it seems to me that most stock buyback plans retire just enough stock to offset dilution from stock options–thereby keeping this part of the compensation process from becoming evident through an ever-increasing share count.

looking at the numbers

The table below lists the big tech companies with the largest amounts of net cash (= cash and marketable securities minus long-term debt).  Although, as I mentioned above, there’s no good way to tell the location of a company’s cash, the lower the tax rate the more foreign earnings–and, I think, the larger the amount of cash parked abroad.  Note that I didn’t factor in long-term investment securities.  (You have to draw the line somewhere, and I decided I wasn’t comfortable deciding about the liquidity of firms’ non-current investments.)  You may want to do this differently, and the company financials are easily available on the Edgar site.

I also show the dividend yield, if any.  The following column shows dividend payments as a percentage of free cash flow ( = cash flow minus capital spending needs).  It gives mostly “negative” information.  That is, if the percentage is high, the company has little scope to increase the dividend, or even support the current payout in bad times.  A low percentage would be a good thing for dividend seekers, if we knew the location of the cash–i.e., whether the cash is available to be paid out.

The next-to-last column shows the stock’s pe based on consensus estimates of earnings to be reported in calendar 2010.  The final column shows what the pe would be if all the foreign-generated cash were to be repatriated and tax paid in the US.

—–stock price–cash/share—–tax rate——-divd—–divd/fcf—–pe—-pe”normal”tax

AAPL      $262            $27           27%        none         n/a           19x             21x

CSCO      $27.01        $4.20        19%         none        n/a           19x             24x

GOOG      $529           $78          22%         none        n/a            21x            25x

INTC        $23.35        $2.50        30%         2.9%      35%         12.6x         13.6x

MSFT      $30.84        $3.70       26%         1.7%       33%            14x            16x

QCOM     $37.92        $7.15        17%         2.0%      38%           18x            23x

my observations

1.  The absolute amounts of cash are huge.  They were astoundingly high percentages of the firms’ stock market capitalizations at the market bottom.  But they no longer are big enough to be a primary feature of the stocks as investments, in my opinion.

2.  The group divides into two camps:  fast growers–AAPL and GOOG; and more mature companies–INTC, MSFT and QCOM.    QCOM is somewhat of an anomaly.  The other stocks declare their growth characteristics through their pes and the presence/absence of a dividend.  QCOM hasn’t expanded much during the last half-decade and pays a dividend, yet has a higher pe than either INTC or MSFT.  This is probably due to its smaller size and its focus on mobile.

3.  GOOG seems to still be a more expensive stock than AAPL, despite the year-to-date outperformance of the latter over the former by about 40 percentage points.  AAPL’s pe is lower and its growth rate higher.  GOOG’s lower tax rate suggests more earning power outside the US, but also the potential issue (perhaps non-issue to everyone except me) of tapping overseas cash.

4.  The INTC/MSFT comparison is also interesting.  They are the two stalwarts of the “Wintel alliance” of the pc era, one the hardware genius, the other the software guru.  The market worries that time has passed both firms by.

INTC has a higher dividend yield and a lower pe, which I think expresses the market’s logical preference for a software company over its more capital-intensive hardware analogue.  Wall Street also believes, I think, that MSFT has an easier migration path away from the pc to more compact internet-centric devices than INTC, which has an obvious rival in ARM Holdings plc.  On the other hand, (I think) INTC has a much stronger management than MSFT.

INTC is paying a higher portion of its free cash flow in dividends than MSFT is, but the difference is slight.  INTC also has a much higher tax rate, indicating higher potential to tap offshore cash.

I don’t own either.  If I had to buy one, I’d pick INTC–but I would also watch very closely developments with the company’s Atom chip line and how it is faring against ARM offerings.

MSFT’s March 2010 quarter

April 25, 2010 By in Current Market Thoughts, earnings conference calls, Industry Analysis, internet, Stock ideas, Technology, Video games, Wireless Tags: , , , , , , , Leave a comment

MSFT reported its fiscal third (ending 31 March) quarter earnings results on April 22.  This is what I thought was interesting from the numbers themselves and the related company conference call.

the results

Revenue, factoring back in sales that are deferred under GAAP, was up 8% year over year.   Operating earnings were up 17%.  The operating leverage is due partly to the fact that incremental copies of software cost virtually nothing to make, and are therefore almost pure profit.  It also comes from continuing strong cost control.

Operating income benefitted a bit from the absence of severance charges ($290 million in the year-ago quarter), but that was offset by higher legal expense and the costs from the search agreement recently concluded with Yahoo and okayed by government regulators in February.

Net income was up by a much larger percentage, around 36%.  Although MSFT didn’t highlight this on the call, the most important reason the number was in the thirties rather than the teens was a $589 million swing from loss a year ago to profit this March on selling investment securities.  A lower tax rate helped a bit as well.

the reasons

Windows 7 adoption has been the fastest of any Microsoft OS, with 10% of personal computers worldwide now running it. (As a frustrated former Vista user writing this on a Mac, I’m tempted to analyze this as more a comment on Vista than on Windows 7.  But I have to acknowledge that W7 seems to have stemmed customer defections.  So it must be good.)

Sales in emerging markets were up by 20%+ year on year, with sales in developed markets advancing around 5%.  MSFT has begun to notice small- and medium-sized businesses upgrading their software, with revenues in this segment up 15%+.

Piracy is down.  Part of this is MSFT’s litigation efforts to enforce its intellectual property rights abroad.  Part is the increasing market share of global branded computer manufacturers vs. independent no-name “white box” makers, where software piracy is more prone to occur.

Worldwide PC sales are up 25% year on year.  MSFT estimates that consumer purchases are up 30%- and business buys up 15$.  Netbooks, where unit revenues are lower but where MSFT currently has almost all the market, are about 10% of the total.  MSFT unit sales are outpacing market growth.

upcoming quarters

Office 2010, the new Office suite, and a number of server software upgrades launch in the June quarter.  They should provide a steady boost to revenues over the next year or two.

In MSFT’s mind (and who would know better?), large corporations worldwide are clearly preparing for a major refresh/upgrade of their computer systems.  Most have pilot or prelaunch Windows 7 efforts under way now.  They’re planning to deploy W7 as quickly as they can, on the server infrastructure they have today.

Why the holdup?  I presume it’s the usual– IT chiefs want to be sure all the major bugs have been worked out of software before risk the firm’s information backbone by using it.  That takes time.

MSFT also has a large “cloud computing” business, its Online Services Division, which looks like it will report full-year operating losses of more than $2 billion.  At some point–I have no guess as to when–those losses will likely begin to diminish and eventually turn to profit.

What does MSFT do for an encore?

This is the (perhaps cruel or ungrateful) question Wall Street will eventually ask about MSFT.  The company generates enormous cash flow, has negligible debt and is in the midst of an extra-profitable period of upgrades to its basic products—the PC operating system/user interface and the collection of Office-brand business applications.

But the consumer portion of this transition, which is bigger than the business side, is quickly closing on its peak.  And since the market lows in March 2009, MSFT’s stock has doubled.  It has outperformed the S&P 500 by about 20 percentage points over this span, which already discounts at least some of the current good news.

my thoughts

I see two striking features of MSFT:  its enormous cash flow, and how that cash flow is deployed.

On the conference call, MSFT displayed justifiable pride in the fact that March quarter cash flow was a stunning $7.4 billion.  The total for the first nine months of the fiscal year was $18.5 billion.

What is MSFT doing with this money?

stock repurchases          $7.4 billion

additions to cash          $5.5 billion

dividends to shareholders          $3.5 billion

capital spending           $1.2 billion.

If I’ve read the balance sheet numbers correctly, about half of the stock repurchases go to offset the issuance of new stock to employees who are exercising stock options.  But about $3.5 billion has been used to shrink the number of shares outstanding by about half a percent.

MSFT already has about $40 billion in cash and short-term investments on the balance sheet?  Does it need more?  I don’t think so.

Anyway, it seems to me that MSFT could easily double its current dividend (not necessarily all at once; a steady increase over a year or more would be ok), which would produce a yield of 3.5%.  To do this would require a courageous further recognition by the company’s management of the firm’s maturity–a judgment Wall Street has long since made.  My guess is that it would do wonders for the stock’s price, even from here.

My initial reaction is that chances aren’t good.  But we can watch for signs.

By the way, I tried using Firefox to access the conference call and download the 10-Q, because I knew that MSFT doesn’t like Safari.  But the 10-Q wouldn’t download, the conference call narrative broke down twice and the timeline bar to skip/rehear portions appeared only intermittently and didn’t work.  I’m sure Redmond residents find this mirthful, but the humor doesn’t travel.