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Friday, August 18, 2006

Microsoft Acts No Different Than a Utility Stock

Microsoft Corp. (MSFT) is up 1.6% at $25.11 right after the open after it today announced the preliminary results of its modified "Dutch Auction" tender offer, which expired last night. Based on the preliminary count, Microsoft expects to acquire approximately 155 million shares of its common stock at a price of $24.75 per share for a total cost of approximately $3.8 billion. These shares represent approximately 1.5 percent of the shares outstanding. Final results for the tender offer will be determined subject to confirmation. The company also announced that the authorization for its ongoing share repurchase program, previously announced on July 20, 2006, has been increased by approximately $16.2 billion. As a result, the company is authorized to repurchase additional shares in an amount up to $36.2 billion through June 30, 2011. SEC rules prohibit the company from purchasing any additional shares until at least 10 business days after the expiration of the tender offer.

What is amazing here is how the company is potentially using a huge portion of its current cash arsenal solely to prop its shares. Even at a $248 Billion market cap and even after it has been dead money this is the largest US tech stock with Cisco (CSCO) at $127 Billion in market cap, Intel (INTC) at $107 Billion in market cap, and its persistent thorn in the side Google (GOOG) at $117 Billion in market cap. General Electric (GE) has a market cap of $350 Billion, Exxon Mobil has a market cap of $404 Billion, and Bank of America (BAC) has a market cap of $235 Billion. As Microsoft buys back shares and retires them permanently (assuming they do) their market cap even at a slightly higher price than today will continue to contract.

The fact that the company did not bid up for recent content deals to beat out Google in the Time Warner (TWX) stake bid for AOL last year and the fact that they weren't even in the ballpark for NewsCorp's (NWS) MySpace is just mind-blowing. It was hamstrung for years in the US with antitrust cases and is still in a fight in the EU. It has a great video game franchise that definitely helped gaming, but the company has still not realized a profit from this in its nearly six year history (time flies). It also holds stakes in dozens of technology and IT companies. Its operating system still rules even in a Linux, Sun Micro (SUNW) and a Google (GOOG) initiative to open up the operating system wars and the office program wars. Its new operating system Windows Vista has been delayed more than enough times, and of course the company has had enough security flaws in the last 8 years to make a non-tech scream. Mr. Gates has even decided to head for the hills and spend the rest of days on his foundation initiatives. The street wanted a share buyback to lower the float, but is that the best strategy for a former growth behemoth? The company now trades with a 20 P/E.

Do not take this the wrong way or that we are entirely negative on the name, because the company may greatly benefit from the next wave of IT spending after we finally get the next operating system upgrade next year and there are many hardware and peripherals that the company may benefit from in the coming quarters. Stock buybacks are good for shareholder worried about potential erosion in share price, but in the long-run share buybacks just make companies smaller and chew up the cash off a balance sheet that could be used for a rainy day down the road. That statement on buybacks is not without controversy and differs greatly from person to person, but that's the take here for what was once the greatest growth story in a lifetime.

As my friend from the Chicago Fed said after the first big dividend announcement, "Well, that's how you turn from a growth stock into a utility stock overnight."

Jon C. Ogg
August 18, 2006

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