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  All That Cash: The Microsoft Dilemma

So what happens when you become one of the richest companies in the world? When you have so much cash in reserve that you can no longer spend it or invest it wisely? That was the dilemma facing the corporate empire of Microsoft. With $60 Billion in its cash hoard, it just became too much for Microsoft to handle. This unwieldy treasure trove was the reason Microsoft announced a plan this week to give a one time dividend payout of $32 Billion to its shareholders. Pending approval from the shareholders, Microsoft will give a special dividend of $3 for each share held on November 17th. In addition, the company also wants to double the ordinary dividend to $0.32/share which would give shareholders another $3.5 billion. Finally, as if that wasn't enough, MS would like to spend up to another $30 billion to buy back some of its stock. That should cause the stock remaining in investors' hands to rise in value.

Sixty billion dollars...$60,000,000,000...that is more than the Gross Domestic Product (GDP*) of Hungary. It is more than the GDP of Iceland, Luxemburg and the Slovak Republic combined. Thirty-two billion dollars is enough to give each and every person in the United States $108. That is the magnitude of the "problem" facing Microsoft.

Lest one think that Microsoft is doing this just out of the kindness of their heart, remember that the SEC has been after them for years for hoarding their money. This excerpt was taken from a USA Today story two years ago.

The SEC alleged that Microsoft's accounting practices from July 1994 through June 1998 caused its income to be substantially misstated.

The agency said Microsoft enhanced its financial results by setting aside artificially large reserves to reduce revenue in good quarters, with the idea of reversing that procedure to record the revenue in less profitable times. The SEC said the reserves totaled between $200 million and $900 million during the period in question.

The SEC has criticized the use of such so-called "cookie-jar" reserves, which it says can give investors an inaccurate picture of the company's current financial performance.

So the company, which resisted pressure to give more of that money back to its shareholders in the form of a larger dividend, has finally given in.

Dilemma One

Microsoft has too much money. I think most of us wished were in that position! When a company has grown so large that it can no longer effectively manage their surplus, it is time to pare down that mountain. So what should MS do with the money? Because solutions like additional research and bug fixing still require MS  to manage the resoures, they must have felt there was only one option left...give it away. And if they have no other choice but to give away some of the extra cash, who should they give it to? There are really only two options: investors or customers?

As mentioned above, Microsoft chose to reward their investors...those individuals and institutions that have purchased a part of the Microsoft empire. However, while that was a noble gesture, Microsoft missed the boat. MS is under attack on many fronts. From the near weekly anouncements of security bugs in their products to the open source movement led by Linux, Microsoft finds themselves in a somewhat defensive position. Using that excess cash to reward the faithful customers of their products would have created much needed good will. But what would be the best way to implement such a plan? I can think of three possible solutions:

Refunds - Giving their loyal customers money back would go a long way toward increasing goodwill. However, I'm not talking about rebates at the time of purchase. Instead, I'm talking about MS giving refund checks back to those who already own Microsoft products. Receiving a $20 check in the mail from Microsoft saying "thank you for supporting our products" would be a very cool thing. How could this be accomplished? Product Activiation. Everyone who legitmately activated their Microsoft products would be eligible for a refund. The bonus for Microsoft would be to further promote Product Activation. While not as effective, they could also send out coupons for their products. I'm not talking talking about 5% off coupons, but rather 50% off. Not only should that spur sales of Microsoft products, but it would assist consumers interested in upgrading to the latest versions of MS software.

Price Reductions - Obviously, if Microsoft has too much cash on hand, then their profit margins are too high. I realize it is a "supply and demand" issue. Microsoft can charge as much as they do, because people are willing to pay it. However, as the music industry is struggling with, products that are priced too high for many customers will end up being pirated. Reducing the cost of their products might just entice more legitimate purchases of their software.

Multi Licenses - I love this idea. We have discussed multi-licensing in the past. With that kind of excess cash, Microsoft could afford to experiment with new licensing programs. Now would be the time to implement multi-user licenses for home networks. If Symantec and Apple could do it, Microsoft can as well. Unfortunately, following in Apple's footsteps may be just too bitter for Microsoft to accept. Of course, if they decided to "one up" those companies, Microsoft wouldn't really be following them.

Microsoft's image could use a proverbial "shot in the arm" right now. Instead of giving money to investors, they should be doing all they can to strenghten current relationships with consumers as well as developing new ones.

Even though the title of this article is "The Microsoft Dilemma", there are really two dilemmas. As discussed above, the first dilemma concerned what Microsoft will do to address this money issue. The second dilemma focuses on the investment community.

Dilemma Two

Microsoft is proposing to give away billions to investors and you only have to own the stock on the record date of November let's all run out and buy Microsoft stock today. It's a sure thing, right? Well, not so fast. It's doubtful this windfall will make you any richer. Taxes due on the dividends alone could leave you with less than you started with...and there is more.

When transferring money from the company to the investors, it makes the company "poorer." In this case, Microsoft would be worth 32 Billion dollars less after this transaction. With all things being equal, a $3/share dividend reward causes the stock to drop $3 a share. So investors would end up with more money, but the stock would be worth less. Then there is the tax issue.

As a disclaimer, this is not a detailed analysis of the tax implications of this move. There are far more qualified individuals to speak on this subject than me.

If the shares are held in taxable accounts, taxes on those gains would be due in 2004. For most investors, those gains would be taxed at 15%. However, if there were no special dividend, there would be no tax due this year. Instead, an investor would pay the 15% Captial Gains tax only after selling their shares for a profit. Investors could postpone paying the taxes by holding on to their shares for years. That is why companies have been paying smaller dividends in recent years. Investors would rather see the gains from increasing share prices than extra dividends.

For those investors who do receive the special dividend, what should they do with it? Spend it? The economy could use the little boost it would give. Reinvest it? Most of the windfall will be reinvested without the investor ever seeing the cash. Many individuals have automatic dividend reinvestment plans. Larger institutional investments (mutual funds, etc.) will also just reinvest the dividends.

For investors, it appears to be a case of mixed news.

Final Thoughts

According to Microsoft, they have so much extra cash that they can no longer manage or spend it wisely. They saw no other option than to give it away. However, they chose to reward their stockholders instead of their loyal customers. In the end, that might be short-sighted. With MS coming under increasing pressure in the marketplace, they need to do everything they can to build goodwill with their customers. By rewarding their customers first, they will also be indirectly benefiting their investors. Because happy customers should translate into increased sales, which in turn, should generate greater profit. In that ideal scenario, it would be a win-win situation.

*GDP = consumption + investment + government expenditures + exports - imports


      Posted by: , July 23, 2004, 6:51 pm  

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