Tuesday, May 12, 2009

Why is Microsoft Selling Bonds for the First Time?

Microsoft recently announced they are issuing billions in bonds, and this is the first time they have ever sold bonds. They plan to use the money they raise for stock buy backs.

I'm convinced for MSFT borrowing money with bonds is a dividend reduction without calling it one.

Some Theory:
Whether you finance your company with bonds or stock doesn't change your company's profitability except for interest and taxes.
Otherwise, the results are mathematically identical.

Also, in theory, if you buy back stock, that should have no impact on your stock price. The cash used by the company for the buyback is company equity.
Spend equity to buy equity. There are fewer shares, but the company is smaller.

So... MSFT issues bonds. In the short term, they trade interest for dividend payments since the stock they buy back no longer gets paid dividends.
(and there's a tax break because interest payments are deductible and dividend payments are not).
And the existing shareholders (in theory) shouldn't see any improvement in their share price.
BUT: They own a bigger share of the company and get only the same amount paid as a dividend.

To take an extreme case, if MSFT borrowed money to buy everyone's shares except For Bill Gates' shares, Gates would get exactly the same dividend he gets now.
Even though he would own the whole company.

In the short term, like I said -- a wash (in theory). The dividends are offset by interest payments and the tax break. So the company doesn't really retain more money.
In fact, it probably chooses to start paying back bonds as profits improve. In the end, the bonds are gone. Paid down. Called. Now there would be fewer shares, and dividends are the same in $/share, but smaller in proportion to the ownership share.
(Each share represents a bigger part of the company, but only gets the same old dividend payment.)

What I don't know:
Why doesn't MSFT just use some of their cash hoard for the buybacks? Their debt does pay pretty low interest, so maybe they just have a better return on their cash already. But they sure have a lot of cash.

A lot of companies believe their stock is worth more than the market thinks it is. They believe in momentum and doldrums and stuff like that. Maybe they believe a few billion thrust into the market to buy back their shares will give it a temporary pop that other investors may see and they just might jump back on board. That would really raise the stock price.

Maybe there's other stuff going on? Companies buy back stock to redeem options. They could have a dozen other reasons for wanting a buyback or issuing debt.

This is just my thought.

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