Microsoft Debt Issuance Makes Zero Economic Sense

Vitaliy Katsenelson's picture

Tuesday's  headline from the WSJ reads: Microsoft Corp. (MSFT)  to offer up to  $1.25 billion in 3-year convertible notes."

The software company will use the sales proceeds to repay short-term debt. If it was any other company I’d ignore this headline as a daily noise as this kind of things happens all the time. But Microsoft has $39 billion of cash and generates $16-$17 billion of free cash flows a year. Issuing short-term debt, for which Microsoft will surely pay higher interest than it receives on the pile of its cash makes absolutely no economic sense – zero.

Microsoft has $1 and $0.75 billion of debt that matures in 2019 and 2039, respectively. Ironically, though this debt comes with higher interest, it makes sense if the company believes that we’ll have significant inflation and it will be paying off its debt with inflated dollars.

When you are sitting on pile of cash that earns nothing, borrowing short-term (three years is short-term) makes no economic sense. It seems Microsoft finance department suffers from the same problem many investors do, it cannot sit on its hands, it has to do something even if it is losing proposition for the company and shareholders

Vitaliy N. Katsenelson, CFA, is a portfolio manager/director of research at Investment Management Associates in Denver, Colo.  He is the author of “Active Value Investing: Making Money in Range-Bound Markets” (Wiley 2007).  To receive Vitaliy’s future articles by email, click here.

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GentleBen's picture

Unknown to most people outside of Microsoft is that Microsoft's investment arm is actually one of their biggest businesses behind Windows and Office. I don't know much about the details of how they trade or what they trade other than commodities (hedge infrastructure costs) and obviously FX.

dumpster's picture

micro look at microsoft .  weather or not 1.2 b.is good economics. perhaps gates 747 needed up grades    

hitting knats with sludge hammers.  rounding error ,

now.... 13 trillion is a sum that may cause heart burn .

 

and effect our lives for worse to worse ,,, microsoft in the scheme of things a nothing burger. article a filler in my humble opinion ... who really cares...    

bIlluminati's picture

MSFT has in the recent past earned 9% on its cash. While I doubt they can do that in 2010, I would assume that they are playing bank. Possibly a tax issue, possibly for a small (for MSFT) acquisition. But I'd make top dollar it is rational. Unless it is for a stock buy-back.

bingocat's picture

Vitaliy,

Forget their cash pile for a second. It is irrelevant from a classical corporate finance perspective, which means it could be AnyCo, not SpecificCo.

If AnyCo has stable cashflow and understands the inputs to its business, as investors in AnyCo we would hope that AnyCo would "arb" the market - buying its stock when the stock price is too low, and selling it when the stock price is too high.

Why would it not do that in this case?

If AnyCo has lots of employees with lots of stock (some restricted, some not, and an actuarial likelihood of owning it), options, and relatively constant acquisition currency needs, and a relatively predictable cashflow generation calendar, not to mention a "desirable" capital structure at any given point in time, it can be said to have a dilution/maturity ladder in price-space and over-time. The easiest way to hedge that price-time capital flow surface is by using options. Most companies in AnyCo's situation could optimize their capital structure over time and price-space by using options.

Sudden Debt's picture

microsoft taking a loan to play inflation...

right...

I SAY THEY PLAN TO TAKEOVER APPLE!!!

Hephasteus's picture

Apple and Microsoft are immune to takeover. They are such giant black holes of cash hoovering nobody can afford to take them over.

Which is why they will be in deep deep trouble because as soon as the economy double dips the perception of them returning to cash machines goes away and they again look like the giant black holes of capital need they are.

Hephasteus's picture

It makes sense. Microsofts a broke piece of shit company with lies for a balance sheet and crap in a box for product.

GoldmanSux's picture

Convertibles are for also rans. I was shocked Microsoft did this. It makes me wonder what disasters await the shareholders.

technovelist's picture

I know why they are doing it: because their so-called "Senior Leadership Team" couldn't lead their way out of a wet paper bag. Therefore, they have to do something random to seem as though they aren't just collecting their giant compensation for doing nothing.

Mitchman's picture

What would have been helpful here would have been an analysis of why in the middle of a market where a) no one is issuing and b) no one has issued converts in a dog's age MSFT would go out and do such a thing beyond generating some fees for its IB's. Pretty superficial reporting IMHO.

Howard_Beale's picture

I agree...where are the gravediggers? WTF would make a reasonable explanation for this folly?

None.

Equity Research Rex's picture

Da Canuck got it-- i didn't see that till now, and its clearly a back dating stock deal as previously noted.

Equity Research Rex's picture

maybe they want some I-Bankers to give them some good ideas on what to do with $1B of short term money --- could be the last billion they spend on creating some sort of social property -- which means a 500M acquisition and then 500M more in marketing it.

 

 

Da Canuck's picture

The debentures pay no interest. See:

http://www.microsoft.com/Presspass/press/2010/jun10/06-08ConvertiblePric...

The convertible notes will not bear interest and the principal amount will not accrete. Prior to March 15, 2013, the convertible notes will be convertible, only in certain circumstances, into cash and, if applicable, cash, shares of Microsoft’s common stock or a combination thereof, at Microsoft’s election. On or after March 15, 2013, the convertible notes will be convertible at any time.

 

--Doug

Howard_Beale's picture

Great...forget the PIMCO idea. I was way off target.

So this is just a way to screw their new bondholders as well as the equity holders.

Nothing here...move along.

metastar's picture

Does Bill Gates, a Bilderberger, know something we don't?

Hephasteus's picture

He knows his ass is broke.

dcb's picture

because of the tax break you lever up the company and your ROE goes up. this means more bonus and higher priced stock. perhaps a way to reward employees who have option grants. It is why management should always receive bonus based n ROA and not roe.

A former CEO told me big piles of cash make you a take over target.

Dr. Acula's picture

>management should always receive bonus based n ROA and not roe.

Both choices are scary.

From Ludwig von Mises' Human Action:

"It is possible to reward the manager by paying for his services in proportion to the contribution of his section to the profit earned by the entrepreneur. But this is of no avail. As has been pointed out, the manager is under any circumstances interested in the success of that part of the business which is entrusted to his care. But the manager cannot be made answerable for the losses incurred. These losses are suffered by the owners of the capital employed. They cannot be shifted to the manager...

 

For society as a whole the squandering of capital invested in a definite project means only the loss of a small part of its total funds; for the owner it means much more, for the most part the loss of his total fortune. But if a manager is given a completely free hand, things are different. He speculates in risking other people’s money. He sees the prospects of an uncertain enterprise from another angle than that of the man who is answerable for the losses. It is precisely when he is rewarded by a share of the profits that he becomes foolhardy because he does not share in the losses too."

Howard_Beale's picture

Yeah, Apple might take them over....LOL. Who else would want the dinosaur? Certainly not Apple or anyone else. They can't buy any other company due to monopolistic concerns (yeah that Yahoo would have put them over the top) and they needed to do SOMETHING. But a teeny tiny little spit of debt? Puh!

They hit the top of their product life cycle a decade ago. Then they fucked everyone by making you buy a fresh copy of their OS for every computer you owned and that didn't work well for their stock, either, did it?

I still run on XP. Love it. MS is the Exxon of tech. Nothing new there but a tiny little debt offering. At least they got some press while Steve Jobs had a hiccup and someone yelled Verizon. This will not change their ROE at all. It's too small.

Howard_Beale's picture

I was thinking the exact same thing when I heard about it. Why? Are the tax breaks and loopholes that they have had all gone? Many years back, with stock options, etc, MS paid no taxes at all. Yeah, that's right. Zero. When they were kings of the world in the late 1990's.

Issuing debt would work for them on the tax side, offsetting their huge cash position that earns bupkiss. Additionally, they are down 75% in terms of equity since Dec 1999. But it is such a small amount of debt, it makes zero sense. Zero.

I SMELL PIMCO. What a nice little safe investment vehicle for one of their funds.

williambanzai7's picture

They have to do something bold and unique.

Howard_Beale's picture

Put that puppy in a picture WB. I dare you to come up with a Windows 7 teeny tiny debt offering..just put Bill Gross somewhere in the background. He needed something and called the other BG and said, hey Bill, how about a little MS debt for the Pimgram?. We need something that isn't going to default.

WestAfricanChief's picture

Sometimes people,nations or companies issue debt when they dont need it,so as to maintain good credit rating. . .

I am guessing thats what MSFT is thinking. . yea they have that big hoard of cash,but they could pay it all off in one swoop in some special dividend to assuage shareholders for being absolutely dead money for 10yrs. . .

THE WEST AFRICANCHIEF

Nolsgrad's picture

shittysoft, do converts so when your stock is down the corp execs who buy all the debt can get super cheap stock pehaps? It's the new back-dating scheme.

jeff montanye's picture

this, or something like it, actually makes sense.  the discussion above treats the debt as straight debt which it is not.  discussion of the equity component seems required to conclude whether or not the finance dept is incompetent.

Mr Lennon Hendrix's picture

Indeed, this is very interesting.

asiablues's picture

Vitaliy, Looks like I spoke too soon.  Good to see you here.

QQQBall's picture

 

Why 3-year year, and why converts?