Opinion

Felix Salmon

Ford’s stock issue makes more sense than Microsoft’s bond

By Felix Salmon
May 12, 2009

Ford is issuing equity and will probably use some of the proceeds to buy back debt. At the same time, Microsoft is issuing debt and will probably use some of the proceeds to buy back equity. Which one makes more sense? The answer, quite clearly, is Ford.

There’s basically only one good reason why companies would want debt rather than equity, especially in these days of deleveraging, and that’s the tax advantages of debt — you pay income tax on corporate profits only after you’ve made your debt-service payments. Ford has lost so much money in recent years that it’s very unlikely to have to pay any tax at all for the foreseeable future — and as a result the less debt it has, the stronger it is.

The case of Microsoft is weirder, mainly because it’s sitting on $23 billion of cash already — why on earth would it need $3.75 billion more? Anything it can do with debt, like buying stock, it can do with cash. And although Microsoft’s debt is cheap — it’s paying only about 100bp over Treasuries, even as most triple-A corporates have a spread of more than twice that — it still is going to end up shelling out significantly more in debt service than it will receive in interest on the proceeds.

The main reason for the Microsoft bond issue, then, is signalling. It’s a way of Microsoft telling the market that it’s still ambitious, that it still wants to grow, that it has some doubts about whether its $23 billion will suffice to fund its plans, and that it wants to lock in low rates now to help finance all manner of wonderful growth over the coming decades.

The question is whether you believe it. My feeling is that Microsoft’s days of fast growth are long in the past, and that it’s increasingly becoming a utility. Not that there’s anything wrong with that. But it does mean that if it already has $23 billion of cash, there’s really no reason to go ahead and issue debt on top.

Comments
7 comments so far | RSS Comments RSS

If they are becoming a utility, that’s all the more reason to have a financial structure with some debt, rather than 100% equity. If they can buy their cheap equity with their cheap debt it could be a good deal from several perspectives.

Posted by steve | Report as abusive
 

Hi Felix – A lot of MSFT’s cash (now up to $25 billion) is generated outside the U.S. So transferring the existing cash horde to dividends or stock buybacks is a taxable event. – Eddy

 

There’s also every reason to believe there is a large acquisition (yahoo, sap) in microsoft’s immediate future, and it is useful for them to get pricing set in advance of that.

Posted by Anurag | Report as abusive
 

A fine piece of corporate finance punditry here Felix.

I agree with you on the future growth prospects of MS; they are definitely not going to repeat history here. Anyways, isn’t buying back equity a fundamental good idea here in this environment if you have the cash for it? This would of course leave the question of why the heck they need to sell paper to finance the re-purchase.

What about your own argument; perhaps they just want to increase the tax shield here?

Claus

 

The potential for an acquisition and the notion that MSFT still wants to grow are good possibilities, but I offer a third:

MSFT is increasing operating leverage so they get greater impact down at the bottom line. MSFT may view (as many others do) that a long period of tepid growth is on the horizon, and in order to generate earnings growth in excess of their peers, it’s time to lever up. Particularly with rates as low as they are.

Posted by Mark | Report as abusive
 

Agreed with Mark and Eddy; The analysis here is quite simple (I’m way too lazy to actually do it, but that’s another story), although I’m not certain if I did it I’d come to the same conclusion as Mr. Softy…

To grossly oversimplify:

If C(Equity) + PV(Tax Sheild) > C(Debt), raise debt, of course this would depend on their projected ROE (C(equity)) and ROA, which I think they’re surely over-estimating, but waddya gonna do?

 

Very smart move by Microsoft. In about three years they’ll be able to invest it in 10 year treasury notes yielding 25%. Free money.

Posted by fred | Report as abusive
 

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