First Take: Microsoft stingy, despite dividend boost
- Software giant has poor record as investor
- More than half of free cash flow kept on ice
SEATTLE – Longtime Microsoft institutional investors this morning welcomed the renewal of a $40 billion stock buyback program, and especially a somewhat unexpected 22% dividend increase.
But the software giant's share price barely moved. At the moment it's up less than 1%. That's because for a giant corporation that generates a mountain of free cash flow Microsoft – even with today's moves -- is still too stingy in rewarding shareholders.
Free cash flow is the money from core operations that's left over after it's reinvested to maintain and grow the business.
Titans like Coca Cola, Colgate Palmolive and Johnson & Johnson that throw off a lot of free cash flow on a consistent basis typically pay their fair share of U.S. taxes and send sometimes as much as 60% or 70% of free cash flow back to shareholders in the form of dividends.
Not Microsoft. Under outgoing CEO Steve Ballmer, the company has piled up nearly $70 billion in foreign securities, for which it pays no U.S. taxes, and – even after the dividend boost announced this morning -- still will convert only about 40% of free cash into dividends, says Dan Ferris, investment analyst at Stansberry & Associates Investment Research.
"It's great, but it could be and should be greater," Ferris says. "Microsoft is a terrible capital allocator. It's the most cash-gushing business in the world. The dividend and buyback impose much needed capital discipline. But there's room for massively more."
William Smead, CEO of Smead Capital Management, couldn't agree more. Smead's fund held a large block of Microsoft shares for years. But he dumped Microsoft three years ago.
Smead became disillusioned with Ballmer's efforts to tap into search advertising, home entertainment and cloud services, while simultaneously sitting on billions in cash he believes should have been returned to shareholders in the form of higher dividends.
"I'm glad for the Microsoft shareholders," says Smead. "It's just ironic that Microsoft has come kicking and screaming into this phase, rather than doing it the gradual way."
Many investors desire to own companies that consistently reward owners with steadily rising cash pay outs. By the same token, investors don't appreciate executives who amass a pile of cash, which invariably tempts them to spend too much on bad acquisitions.
Case in point: the $6.2 billion Ballmer spent in 2007 to acquire advertising tech firm aQuantive. Microsoft was forced to write down $6.2 billion last year to essentially shut down aQuantive. By contrast it paid about $7.5 billion in dividends in its last fiscal year.
"Microsoft should be paying out well more than half of it's free cash flow in dividends; it's not even half yet," says Ferris.
Microsoft's entrenched software businesses require very little capital investment but gushes enormous amount of cash. The company had record revenues topping $73 billion in its last fiscal year.
"There's so much cash, that they can't re-invest it all, so it just sits, and when cash sits you tend to fritter it away," says Ferris.
Smead wonders how much Ballmer's recently announced retirement, scheduled a year from now, played into today's 22% dividend boost.
"Ballmer is basically on the way out the door so it seems like they're now running on the board's vision, and the board is run by Bill Gates," says Smead. "So if this is being driven by Bill Gates, why doesn't Gates just come back and run the company?"