The New York Times | Strategies, November 7, 2015 column: "Microsoft’s Stock Math: Fewer Shares, Pricier Shares" [Practical use of buybacks when capital is not needed to produce goods and services]

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Practical use of buybacks when capital is not needed to produce goods and services


Source:  The New York Times | Strategies, November 7, 2015 column

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Microsoft’s Stock Math: Fewer Shares, Pricier Shares

NOV. 7, 2015


Microsoft has been on a roll. Late last month, it did something it hadn’t pulled off since Bill Gates was chief: Its share price reached a new high.

The achievement was so long in coming — the last peak was on Dec. 27, 1999 — that it seemed to elicit more snide comments than outright celebration: “If you’ve stuck with it over the last 16 years, congratulations on finally getting back into the black!” the Bespoke Investment Group wrote to its clients.


Satya Nadella, chief executive of Microsoft, which generates a lot of cash, though it’s no longer a fast-growth company. In 10 years, it has used $123 billion of that to buy its own shares. Credit Divyakant Solanki/European Pressphoto Agency


While Windows and Office, Microsoft’s two big cash cows, have churned out profits and its new chief executive, Satya Nadella, has been trying for a turnaround, there are good reasons to be skeptical of Microsoft’s record.

First, the new highs aren’t real, by which I mean the $53.60 peak of 1999 would amount to $76.56 today in inflation-adjusted numbers, and while the stock rose again last week, it is still trading below $55. In real dollars, Microsoft still has a long way to go. Second, in achieving its current share price, Microsoft has engaged in stock buybacks, a form of financial engineering that is both popular and controversial.

There is nothing intrinsically wrong with buybacks, said Aswath Damodaran, a corporate finance professor at New York University. They are a powerful weapon, he said, neither good nor bad in themselves. “It all depends on the company and the timing and on how you use them,” he said.

Microsoft has used buybacks well, in his view, though its need to do so says some uncomfortable things about the company and our current situation. “I applaud Microsoft for being realistic,” he said. Microsoft still generates a lot of cash, but it no longer is a hyperkinetic engine of growth, he added.

“Tech companies live in dog years,” Mr. Damodaran said, “and being 10 years old in tech is often like being 70 years old for a company like Procter & Gamble.” Microsoft began showing its age in the late ’90s and has gradually accumulated self-knowledge, he said. “It’s like a 61-year-old who has become comfortable with himself and has decided to act appropriately.”

Basically, he said, Microsoft has used substantial sums of money to change its stock market profile by shrinking itself. In December 1999, its market capitalization was more than $600 billion. Today, its market cap is only about $430 billion.

For years now, Microsoft has been systematically buying back its shares, reducing its total share count. Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, tabulated the numbers. Over the 10 years through June, Microsoft spent $123.6 billion buying back shares. That is more than any other company (though Apple, with $90.2 billion in buybacks, has been catching up). Going back to 2004, Microsoft has bought $136 billion in shares through June, Mr. Silverblatt’s figures show, reducing net share count by 26 percent.

For any company — and many of them are doing it — reducing share count through buybacks has great advantages. If earnings stay the same but share count falls, then earnings per share rise, as if by magic. That will, not incidentally, help executives whose compensation is often tied to earnings-per-share targets, which are suddenly easier to reach.

Before the Securities and Exchange Commission clarified buyback rules in 1982, dividends were far more common as a means of funneling money to shareholders, which buybacks do, too. But nowadays buybacks are more popular, partly because they are a more flexible instrument for chief financial officers, Mr. Damodaran said. “Investors often expect dividends to be permanent, like coupon payments for bonds — even though, legally, dividends can be canceled — and they’re shocked when that happens,” he said. Paring down buybacks is more easily accepted by the markets, he said.

In addition, buybacks may help drive up share prices, though it’s difficult to prove, said Edward Yardeni, an independent economist and strategist who has written frequently about buybacks. The buyback effect on earnings per share is just simple math, he said, and it “is utterly meaningless if you understand it, because the company’s earnings don’t change, yet it seems to have an effect on the markets.” Furthermore, by buying shares at opportune times, companies may be able to bid their own share prices higher. That’s why Senator Elizabeth Warren, Democrat of Massachusetts, called buybacks “stock manipulation” and has asked the S.E.C. to investigate.

It’s also possible, as Ms. Warren has charged, that companies could better use their cash by pouring it into factories and research that would create jobs. But it’s also true that executives frequently fritter away big hunks of cash on fruitless endeavors and foolish acquisitions.

Microsoft has done just that repeatedly, Mr. Damodaran said. In July alone, it wrote down the value of its disastrous acquisition of Nokia, the Finnish phone maker, by $7.5 billion. “Microsoft hasn’t used cash well that way,” he said. “Corporate executives often don’t. It’s often much better to simply return cash to shareholders.”

Including buyouts and dividends, Microsoft returned to shareholders a net yield of 7.22 percent of the value of their shares in the 12 months through September, he calculated. As a strategy, the maneuver works in several ways. Because Microsoft is one of only three nonfinancial American companies with a triple-A rating (along with Johnson & Johnson and Exxon Mobil), it gets extremely favorable rates in the bond market, as it did last month, issuing $13 billion in debt. It can use that cheap money for buybacks and dividends, deducting interest payments from its domestic income while keeping all but about $3.3 billion of its $99 billion of cash and liquid investments overseas, Moody’s estimated. All of that lowers Microsoft’s American taxes, Mr. Damodaran noted.

Microsoft’s approach is both disturbing and admirable, he said. “As citizens, we are getting the worst of both worlds, but under current tax laws and with interest rates as low as they are, the buybacks are very smart,” Mr. Damodaran said. Under current circumstances, many intelligent C.F.O.s will be strongly motivated to use them.


A version of this article appears in print on November 8, 2015, on page BU6 of the New York edition with the headline: Microsoft’s Buyback Engineering.


© 2015 The New York Times Company


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