Times will certainly change but for the moment, Microsoft is offering a good deal to its investors and could more of it. What Microsoft announced was that it was increasing its dividend. Not a big surprise when you know how much cash the company has on its balance sheet. We had discussed Microsoft as a strong dividend play in our newsletter (sign up for free if you have not done so already). However, the way that Microsoft proceeded was the more surprising part.
A few days after Cisco (CSCO) announced it would start paying a dividend, Microsoft announced it would hike its own dividend from $0.13 per quarter to $0.16, a 23% increase which is more than most were expecting. No one doubts that Microsoft can afford to make this payments but they decided to do in an unconventional way….
Where is the money coming from?
It’s fair to say that most companies paying dividends get their money in one of two ways. Either the company has a significant amount of money that it can pay off over time or the company has enough cash flow to pay for the dividend every quarter and bases the payout on how much money it expects to make in the short to medium term.
While Microsoft could very easily have taken any of the two roads, it decided that it did not want to commit too much of its future earnings into dividends which is understandable with all of the mergers and acquisitions currently going on in the Tech area. So you probably assume that Microsoft will be using its huge pile of cash right? Not exactly. Yes, the company based in Redmond has $36.8 billion in cash and short term investments. Apparently, a very large portion of the money is “offshore” and would be taxed by the US government if it was brought back to pay these dividends.
Microsoft takes a third road
Instead, Microsoft decided to issue some debt, by selling corporate bonds. That is the joy of being a AAA rated company. It sold $4.75 billion of 3 and 5 year debt paying 0.875% on the 3 years and 1.625% on the 5%. In case you are not familiar with bond interest rates, these are very very low. Basically, Microsoft is getting the money for free and then paying it off to investors in form of dividends.
Investors consider Microsoft almost immune to going bankrupt. In fact, Microsoft is paying almost the same rate as the US Treasury, which is basically the lowest rate possible right now for US$ issued bonds. Microsoft intends to use the money to pay the dividend, buy back more shares and also increase its short term assets.
So Microsoft is getting “free” money and sending it to investors
Sounds like a great deal isn’t it? If you and I can borrow money at higher rates, we would probably benefit from Microsoft borrowing more money and sending it to us right? Of course it sounds good but there are many reasons why that could not work
1-Obviously, as Microsoft borrows more money, it will become vulnerable and as we experienced during the credit crises, it is much better for a company to have a strong balance sheet…Also, as Microsoft would add debt, its interest cost would increase as investors would add a “risk premium”.
2-Microsoft is also trying to maintain that it is a growth company and increasing the dividend payout too quickly could be seen as a sign that the growth period is over.
All of that being said, I do expect Microsoft to continue to hike its dividend payout over the next few years which makes it a very good target for a passive income portfolio with a dividend yield already over 2%. Do any of you plan on buying Microsoft?