Last September, Microsoft (MSFT) announced that it would increase its quarterly per share dividend payout from $.20 to $.23.  We were so disappointed in the incrementalist dividend increase implemented by Microsoft we expressed our desire that Microsoft should just bite the bullet and pay the up to 35% repatriation tax on its $50B (as of FY 2012) of net foreign liquidity to pay shareholders a special dividend of $4/share.  We then followed it up with alternative proposals to liberate Microsoft’s foreign source liquidity that would not result in Microsoft paying $17.5B to repatriate the foreign source liquidity to return it to shareholders.  Microsoft’s recent announcement that it was boosting its dividend by 21.7% from $.23 to $.28 and repurchasing $40B worth of its stock was a case of good news and bad news.

The good news about Microsoft’s recent dividend boost was that this was larger than the 2012 dividend increase in terms of dollar amount increase as well as percentage growth.  Microsoft’s 2012 dividend increase was $.03/share and represented a 15% increase versus the 2011 dividend level.  Meanwhile, the 2013 dividend boost was $.05/share and represented a 21.7% boost versus the 2012 dividend.  Microsoft’s recent dividend increase was the 10th time it has increased its quarterly equivalent dividend payment per share in the last 11 years.  Microsoft initiated dividend payments in February 2003 ($.08/share) and made two annual equivalent dividend payments of $.08/share in February 2003 and $.16/share in October 2003 before initiating regular quarterly dividend payments of $.08/share in August 2004.


Source: Microsoft Investor Relations

One thing we would strongly prefer is if Microsoft was to disclose its U.S. source domestic income in its financial reports and conference calls so investors can see how much Microsoft can pay out to its shareholders without having to borrow cash or even repatriate foreign source income and cash.  Microsoft earned $21.9B in FY 2013 and 53.1% of its revenues came from the U.S. market according to its FY 2013 Annual Report (Page 87).  If we assume that Microsoft USA has the same profit margin as Microsoft International, we would estimate that Microsoft USA earned $11.61B in FY 2013 ($1.37/share) and that Microsoft International earned $10.25B ($1.21/share).  Analysts are forecasting that Microsoft will increase its worldwide EPS from $2.58 in FY 2013 to $2.76 in FY 2014.  If Microsoft USA generates 53.1% of Microsoft’s worldwide income in FY 2014, Microsoft USA will generate $1.466/share in domestic source income that it could pay to shareholders as dividends, which is 31% more than the $1.12/share in dividends that it will pay to shareholders in FY 2014.


Source: Microsoft Investor Relations and our Estimates

Microsoft also recently announced that it would repurchase $40B worth of stock.  At first, we were delighted to see this program since we thought Microsoft finally decided to return part of its foreign source cash to shareholders.  However, after further review, we saw that Microsoft authorized this share repurchase program to succeed its $40B share repurchase program that took place from 2008 to 2013.  As this program has no expiration date, we believe that Microsoft will take another five years to repurchase another $40B worth of its common stock.  Furthermore, this repurchase program does not take into account shares issued from employee stock compensation programs.  Microsoft’s $40B repurchase program only reduced its share count by 1B shares (from 9.47B to 8.47B or 10.6%) from 2008 to 2013 because Microsoft issued $11.9B worth of its stock through its employee stock compensation programs.


Source: Morningstar Direct

Microsoft also announced that it signed an agreement to cooperate with activist investor ValueAct Holdings.  ValueAct had recently pushed Microsoft to return more of its cash to shareholders.  Under the agreement, Microsoft will hold regular meetings with ValueAct’s President Mason Morfit and ValueAct has the option having Morfit become a director beginning at the first quarterly board meeting of 2014.  According to The Seattle Times, pressure from ValueAct may have been a factor in Ballmer stepping down as Microsoft’s CEO.  ValueAct is not the only firm that has expressed interest in Microsoft returning more of its cash to shareholders.  Last year, we called for Microsoft to return cash to shareholders even if it meant paying repatriated profits taxes.  We also shared our own cash return proposals to avoid repatriated profits taxes as well as the proposals highlighted by Whitney Tilson and Strategic Analysis Corporation.

In conclusion, we are content that Microsoft increased its dividend at a stronger rate this year relative to last year and that it will continue to repurchase shares.  However, we believe that Microsoft needs to pay out its foreign source liquidity holdings and cash flows to shareholders in order to monetize the value of its holdings.  We are aware that the Internal Revenue Service is looking at ways to clamp down on the ability of firms to avoid punitive taxation on repatriating company profits and assets. However, at some point, we believe that it would be better for Microsoft to repatriate its foreign cash and pay it out to shareholders even if it has to pay repatriation taxes instead of leaving its assets festering away in low-yielding fixed income securities.  Microsoft needs to realize that its days of exceptionally strong growth are gone.  Microsoft’s decelerating EPS growth and its inability to maintain a strategy in mobile communications is why its total return since the end of FY 1999 has been flat.


Source: Morningstar Direct


Past performance is not necessarily indicative of future results. All investments involve risk including the loss of principal. This report is confidential and may not be distributed without the express written consent of the original author and does not constitute a recommendation, an offer to sell or a solicitation of an offer to purchase any security or investment product. Any such offer or solicitation may only be made by means of delivery of an approved confidential private offering memorandum.

Investments may currently or in the future buy, sell, cover or otherwise change the form of its investment in the companies discussed in this letter for any reason. The author hereby disclaims any duty to provide any updates or changes to the information contained here including, without limitation, the manner or type of any of the investments.

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Disclosure: Analyst(s) covering this company does not have a position in MSFT. 

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