Memo to Microsoft: Show Us the Money

Check out this Barron's article:

Memo to Microsoft: Show Us the Money

It turns out a memo to Microsoft (MSFT) from an anonymous hedge fund had to say last week proposed using cash and debt to buy back 20% of the stock and a boost of the dividend to 6%.

Apparently, the memo was authored by Ivory Investment Management, a shareholder since 2006. According to the article, the firm believes in Microsoft's prospects and had nothing negative to say about CEO Steve Ballmer (unlike some other high profile Microsoft shareholders). The focus of Ivory's criticism is on capital structure.

Some other things worth noting.

Microsoft has returned $ 150 billion to shareholders in the past decade in the form of buybacks and dividends. Shares outstanding have dropped by nearly 25% over that time. So, to an extent Microsoft has been doing what the memo asks just not aggressively enough.
(though it's not like $ 150 billion is a trivial sum of money)

In the late 1990s, Microsoft's enterprise value/earnings multiple was ~60x but is now less than 10x. So quite a bit of the stock's poor performance comes down to substantial multiple compression. The business performance, if not nearly as spectacular as something like Google (GOOG) or Apple (AAPL), has actually done just fine.

If Microsoft's business continues to perform then that compressed multiple, if annoying in the short run, will serve patient shareholders in the long run by allowing more shares to be bought cheaply.

The Barron's article also makes the point that since Microsoft can borrow at 3% and use the funds to buy its own stock with a 12% free cash flow yield, it seems an easy call.

I think it is.

What the memo says does make a lot of sense but I wouldn't bet on it happening any time soon at Microsoft.

Yet, there are quite a few other businesses have a similar opportunity to borrow at low rates then buyback a stock that has a much higher earnings yield. The difference in that spread to the direct benefit of remaining shareholders.

There may be an aggravating lag in stock performance but, as long as the business itself performs reasonably well, the benefits measured in enhanced long-term shareholder returns will not be insignificant.

Check out the full article.

Adam

Long positions in MSFT, GOOG, and AAPL

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