This weekend’s news that Microsoft (NSDQ: MSFT) has withdrawn its offer for Yahoo (NSDQ: YHOO) after deciding that it would not be appropriate for the company to raise its offer will likely begin a familiar discussion on what Microsoft should do with its huge cash position. From the outset, the deal was questionable as it was clear early on that Microsoft shareholders were not in favor of buying Yahoo. Any other acquisition that would be as dilutive is now also unlikely as Ballmer & company are clearly on the defensive in their quest to build shareholder value at Microsoft. What is Microsoft to do then?
One option in my opinion is to undertake a substantial share repurchase, similar to the one conducted several years ago, in the hope of giving the company’s earnings per share figure a boost. It is by far the safest option for management, as it poses no integration risks and allows management to stay focused on software. Currently, the company has about $26 Billion in cash and short-term investments that yielded a little less then $1.5 Billion or so over the last year. As such, any calculation made to try to figure out the company’s earnings per share would have to take the loss of this income into account. In addition, if the company were to take on debt to expand the repurchase those figures would also have to be set and taken into account. In my analysis, I had Microsoft issuing bonds with a 20-year maturity at about 6% with the principal repaid evenly over the period. The 6% figure would likely be high, as triple A rated corporate debt is in large demand right now.
Here are some of my calculations:
| Level of Share Repurchase | EPS Total for Next 4 Qs (Previous 4Qs EPS Total was 1.81) | Shares Outstanding |
| None | $19.17 Billion or $2.06 | 9.30 Billion |
| $26 Billion in Cash & No Debt | $17.67 Billion or $2.10 | 8.40 Billion |
| $26 Billion in Cash & $10 Billion in Debt | $16.57 Billion or $2.06 | 8.05 Billion |
| $26 Billion in Cash & $20 Billion in Debt | $15.47 Billion or $2.01 | 7.71 Billion |
| $26 Billion in Cash & $30 Billion in Debt | $14.37 Billion or $1.95 | 7.36 Billion |
| $26 Billion in Cash & $40 Billion in Debt | $13.27 Billion or $1.89 | 7.01 Billion |
| $26 Billion in Cash & $80 Billion in Debt | $8.87 Billion or $1.57 | 5.63 Billion |
From the extremely rough calculations above, it is clear that it will be very hard for Microsoft to add significant value for its shareholders regardless of what it does. Yet, a large share repurchase, financed with $26 billion in cash on hand and another $20 to $40 billion in debt would go a long ways to pleasing shareholders, as it would add earnings leverage to Microsoft for the first time in decades. Microsoft’s large cash flow generation would allow it to repay the debt much faster then the 20-year figure I used in my calculations. This gives them the ability to undertake a large repurchase without the fear of analysts or investors hammering the company’s stock price to severely as the earning per share would likely climb considerably within 3-5 years as the debt is repaid faster then a normal bond issue.
While getting money from banks to undertake the buyout is clearly out of the question (a term loan would be preferable as it would be easier to repay then bonds), I’m sure the bond market would easily digest an offering from Microsoft as it would likely be as safe as a Treasury and yield slightly more. With interest rates at near all time lows, this just might be the time for Microsoft to undertake such an action. If the Federal Reserve is forced to raise rates substantially later this year or at the start of 2009, Microsoft’s repurchases would undoubtedly look quite smart. This would leave the remaining shareholders benefiting tremendously from the effect of organic growth and the power of inflation to help long term fixed rate borrowers.
Will Microsoft be this aggressive though? Likely not, as they have a stated policy of keeping considerable cash on hand for such things as R&D, legal expenses, operations and acquisitions. However, it is fun to speculate nonetheless.
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