Ford's Stock Issue Makes More Sense than Microsoft's Bond

Ford is issuing equity and will probably use some of the proceeds to buy back debt. At the same time, Microsoft is issuing debt and will probably use some of the proceeds to buy back equity. Which one makes more sense? The answer, quite clearly, is Ford.

There’s basically only one good reason why companies would want debt rather than equity, especially in these days of deleveraging, and that’s the tax advantages of debt — you pay income tax on corporate profits only after you’ve made your debt-service payments. Ford has lost so much money in recent years that it’s very unlikely to have to pay any tax at all for the foreseeable future — and as a result the less debt it has, the stronger it is.

The case of Microsoft is weirder, mainly because it’s sitting on $23 billion of cash already — why on earth would it need $3.75 billion more? Anything it can do with debt, like buying stock, it can do with cash. And although Microsoft’s debt is cheap — it’s paying only about 100bp over Treasuries, even as most triple-A corporates have a spread of more than twice that — it still is going to end up shelling out significantly more in debt service than it will receive in interest on the proceeds.

The main reason for the Microsoft bond issue, then, is signalling. It’s a way of Microsoft telling the market that it’s still ambitious, that it still wants to grow, that it has some doubts about whether its $23 billion will suffice to fund its plans, and that it wants to lock in low rates now to help finance all manner of wonderful growth over the coming decades.

The question is whether you believe it. My feeling is that Microsoft’s days of fast growth are long in the past, and that it’s increasingly becoming a utility. Not that there’s anything wrong with that. But it does mean that if it already has $23 billion of cash, there’s really no reason to go ahead and issue debt on top.

Disclosure: No positions

Comments

[User 283977:]

I think there are cheaper ways of sending a PR message then taking on 3.75b in new debt. My guess is multiple acquisitions, and one of those is likely to involve Yahoo. Might be an interesting play developing.

May 12 11:34 AM

[Jared:]

Wow! Where does Seeking Alpha find these guys? Did the auther ever take a basic corporate finance course? Has he ever heard of weighted average cost of capital?

It makes absolutely perfect sense for Microsoft to do this. It's growth curve is clearly not as vertical as it once was. This is what maturing companies do to lower their cost of capital. It's a boon to equity owners.

There was an unmistakable signal from the U.S bond auction last Thursday. The rates have bottomed out. They are going higher from here. It is last call for those who have the desire and ability to secure debt on the cheap. The train is leaving the station.

Bravo to Microsoft! It was an excellent move.

May 12 12:12 PM

[Poor Texan:]

I think that Microsoft is obtaining funds while debt is cheap as a hedge against inflation.

May 12 12:18 PM

[Vox Rationalis:]

Debt is cheap - it may not remain so. If inflation becomes the problem many expect, it's quite possible that borrowing today and just sticking the funds in interest-bearing investments will turn out to be profitable.

Additionally, Microsoft stock can certainly be viewed has historically cheap. With a current dividend of about 2.6% (after tax), borrowing to repurchase stock doesn't look like a very expensive proposition.

Does it make sense? It does to me. But what the hell do I know, I'm just a common stockholder.

May 12 12:31 PM

[EJL:]

This move shows that Microsoft has no clue what they are doing. They don't need the extra cash. They generate a ton of it. If they can't fund their growth internally at this point, they should shut the company down and give all the money back to shareholders.

May 12 12:41 PM

[H.J. Huneycutt:]

As "Jared" above states, this is elementary corporate finance.

The reason why MSFT is doing a debt offering is precisely because it has too much cash! The goal isn't to obtain more cash --- the goal is to alter their capital structure. They take on more debt and buy back stock with that cash in order to do so.

Felix is also wrong about there being no advantages to debt financing. The biggest advantage to debt financing is that it increases profitability for the common shareholders so long as the company can earn a greater return than they have to pay out in interest. For instance, if a company is earning a 10% and paying 5% interest, and it can do so consistently, it might make sense to take on more debt.

Of course, there are limits to how much debt firms should take on. In MSFT's case, they bring in HUGE cash flows every single quarter and have no debt. It makes more sense to add a small bit of debt financing to their capital structure given the strength and stability of their cash flows. Otherwise, the stock is just going to be stuck in neutral for quite awhile.


Ford's equity offering makes sense as well, but for different reasons. They need more liquidity and less risk. Hence, they need a capital structure more heavy on equity.

Both MSFT's and F's moves make perfect sense.

May 12 01:47 PM

[terryt:]

There's nothing wrong to leverage balance sheet as MSFT did. No one is paying millions in fee and interest expense to just "signaling".

May 12 01:55 PM

[Lightway:]

So all have all the 100 billion in share buybacks over the past few years been a boon to equity investors? This stock has done nothing in the past 10 years, so I'm not really feeling these, "good for the investor" comments coming out.

I'm also not buying any of the comments here that this is a good move for them to get debt, "just because they can and that's what mature companies do."

The Microsoft growth curve is not as vertical as it once was, but the whole problem here is the lethargic acceptance of the status quo flatlining of the organization. Felix made a very valid point, that Microsoft is fast becoming a utility, not the landscape defining gorilla that it once was, and that is the problem.

Many are content to see it turn into a has-been, accepting corporate finance games, when there is a much bigger pie available if Microsoft would just go out and grab it the way it used to.


On May 12 12:12 PM Jared wrote:

> Wow! Where does Seeking Alpha find these guys? Did the auther ever
> take a basic corporate finance course? Has he ever heard of weighted
> average cost of capital?
>
> It makes absolutely perfect sense for Microsoft to do this. It's
> growth curve is clearly not as vertical as it once was. This is what
> maturing companies do to lower their cost of capital. It's a boon
> to equity owners.
>
> There was an unmistakable signal from the U.S bond auction last Thursday.
> The rates have bottomed out. They are going higher from here. It
> is last call for those who have the desire and ability to secure
> debt on the cheap. The train is leaving the station.
>
> Bravo to Microsoft! It was an excellent move.

May 12 02:07 PM

[The Aft Deck:]

I would much prefer a bag of MSFT shares to a bag of Ford shares. Never underestimate Microsoft.

May 12 03:40 PM

[EJL:]

Huh? How about Vista? How about their online service division losing hundreds of millions? Windows Mobile? I think you meant always underestimate Microsoft...and you'll be dead on.


On May 12 03:40 PM The Aft Deck wrote:

> I would much prefer a bag of MSFT shares to a bag of Ford shares.
> Never underestimate Microsoft.

May 12 03:57 PM

[Toronto Day...:]

some good points but I agree with Jared's comment -- to add to this, good companies will raise money when they don't need it (or who knows, MSFT might need it, it's anyone's guess). This might be the equivalent of someone remortgaging their home to take advantage of cheap interest rates. Not to mention shareholders love to see their stock increase in value -- share buy backs can achieve this. Ford's issuing of shares would be considered dilutive.

May 12 04:03 PM

[donzelion:]

Yahoo schmahoo. Debt financing at low, low rates means that Microsoft could add to its stable of revenue streams with some novel products that have at least a fighting chance of playing to their strengths. Were they to buy, say, Skype or a comparable product, they'd get a double inflation hedge (assuming that Skype calls can raise prices to keep pace with inflation).

May 12 06:02 PM

[zagrebzagreb:]

Indeed… After finishing the second paragraph I’m wondering why this guy has a podium to speak from...

Optimal debt/equity structures are a cornerstone of corporate finance; if Mr Felix Salmon has yet to master such basics, he shouldn’t be pontificating.

Sorry to be an ass about this, but I’d appreciate a higher level of discussion.

May 12 09:53 PM

[guymar:]

It seems to be an illustration of the CNBC factor: once you have been in print or on tv, or you have your own website you can post anything here, even nonsense. Editorial policy someone?

May 13 06:53 AM

[americafirst:]

It's almost like refinancing your home, after it's paid off, even though you are already sitting on a nest egg! No wonder our country is in the mess it's in! Must be that IVY league education.

May 13 10:30 AM

[nyoneway:]

As the saying goes, "a bird in hand is worth two in the bush". With interest rate being so low today and the anticipated inflation going through the roof, why not take equity out of your home and put it assets that has a better chance of higher returns?

It doesn't need a Ivy edumation to understand that.

Not to mention that considering the state of the economy, I rather take on a $300k long term debt on 5% interest and stash it away for a rainy day. That's cheap insurance. Even if I'm out of a job for a few years, I can live off that cash.

On May 13 10:30 AM americafirst wrote:

> It's almost like refinancing your home, after it's paid off, even
> though you are already sitting on a nest egg! No wonder our country
> is in the mess it's in! Must be that IVY league education.

May 13 11:43 AM

[americafirst:]

At least the lenders will be happy. Unless you can pick out the EXACT stocks that may or may not be doing well. I don't believe that you can expect the stock market overall to give you those "higher returns". Neither a lender or a borrower be!

May 13 11:51 AM