Photo: Associated Press
Microsoft (MSFT) shares are falling today, even as the company announced it would increase its dividend by 23% and issue $6 billion in debt, debt on which it could pay as little as 3.73% interest.Apparently investors were less than excited by the news. Perhaps they’re scared by Microsoft’s mounting growth challenges and persistent inability to break into huge new businesses (XBox, excepted)–or maybe they wanted a higher dividend hike. Regardless, the shares are trading near their 52-week lows.
But here’s the only crucial question for Microsoft investors: Can the company last another 10 years? If so, the stock is cheap.
Because Microsoft is awash in cash and will be for years.
The cash monster everyone loves to hate, but is secretly jealous of. Despite all the reasons to criticise Microsoft, its current business remains a cash cow with customer lock-in most competitors dream of.
Thus given the depressed nature of MSFT shares right now, the crucial question for investors is actually simple: Can the company milk its current business model for just another 10 years? We don’t need another Apple here.
This is because the company generates substantial cash and it already has more cash than it knows what to do with (see dividend), and it can raise dirt-cheap cash via bonds, as will be soon shown by its upcoming $6 billion debt issue.
This means Microsoft can just buy 20% of itself out of the market with ease. For example, given Microsoft’s $210 market capitalisation vs. $190 billion enterprise value, the company has about $20 billion in net cash. This means that nearly 10% of each Microsoft share is backed by cash in the bank already, from a liquidation perspective, and the company could buy 10% of itself back from the stock market just using this reserve. It could also pay the cash out in dividends.
Microsoft is also expected to earn $2.35 per share this fiscal year based on consensus, which when compared to the stock’s current $24.40 share price means that each year Microsoft also has the capacity to buy back 9.6% (nearly 10%) of its shares out of the market. It also could pay a much higher dividend than it currently does, even after today’s announced 23% increase. Note we aren’t even calculating actual cash flow here, which is higher than MSFT’s reported accounting earnings.
So just based on one year of earnings and cash on the balance sheet, the company could manage a nearly 20% buyback of its shares from the market.
Now imagine the company can just last a few more years–which it obviously will. Consensus forecasts expect Microsoft to grow its earnings during the net fiscal year, with the consensus EPS forecast at $2.63. Future, low growth is also expected over the longer-haul. But let’s just forget about growth. Expected growth is nice, but let’s just look at potential growth as a buffer above the current earnings level of Microsoft. Just give use another 8-9 years of $2.35 earnings and Microsoft could almost buy itself completely out of the market by the end of the period. It just needs to hang in there and potential growth could provide a margin of error for potential business areas where income is eroded.
Then throw in the ability to issue cheap debt. Microsoft can also expedite the above process by issuing $60 billion in debt and still remain far from a leveraged company. Even paying 5% on this debt would amount to just $3 billion per year in interest, and Microsoft could buy nearly another 30% of itself out of the market at the current share price. Microsoft earns well over $20 billion in profit per year, so covering that $3 billion in interest cost would be easy. Thanks Mr. Bernanke.
Thus Microsoft could roughly buy 10% of itself out of the market with its cash hoard, 30% of itself with a shift towards debt financing, and then the remaining 60% of its shares with just about 6 years of no-growth. To make it safe, let’s say it takes 10 years because earnings are gradually eroded (Despite the fact that most analysts still expect some degree of growth.) and it has to pay some interest on its debt in our scenario.
So just sit there and don’t die too fast. The detailed maths can be done at home, and everyone should do their own due diligence, but the point here is that Microsoft likely doesn’t need to do anything fancy in order to justify its current share price. It just needs to sit around and not die too quickly and it will likely generate more cash than it’s worth right now in the market over the next 10 years. If the stock market doesn’t realise this over time, then it wouldn’t be crazy for someone to step in and try to buy the company right out of the stock market.
Disclaimer: The author or his associates could have exposure to Microsoft shares at any time and without notice. This is not an investment recommendation and data may be subject to error despite best efforts. The author’s opinion could change at any time.