Microsoft: Payday For Shareholders

| About: Microsoft Corporation (MSFT)

Investors in Microsoft (NASDAQ:MSFT) finally received some good news after they reacted negatively to the deal with Nokia (NYSE:NOK) in recent weeks.

The company outlined a new capital deployment strategy and plan ahead of a large meeting with analysts on Thursday.

The company announced a new share repurchase program, accompanied with a solid dividend hike, which provides a new foundation under the shares as the company is navigating to grow operations in the coming decade. Note that after Ballmer's departure, no new CEO has been appointed yet.

The total yield to shareholders, including share repurchases, combined with sufficient financial flexibility, should provide a foundation under the shares.

Tuesday's Announcements

Microsoft announced a major payout package to its shareholders on Tuesday before the market opening. The Redmond software giant announced a new share buyback program totaling $40 billion, sufficient to retire between 14% and 15% of total shares outstanding at current levels.

By all means, on both a relative and absolute basis, the plan is very sizable. Note that the impact of the plan on the shares depends heavily on the timeframe in which Microsoft aims to complete the program.

The new buyback program replaces the previous plan which was launched in 2008 and expires in September of this year. Unlike the previous plan, the new repurchase plan does not have an expiry date. As mentioned before, shareholders might have been looking for an "expiration" date of the plan to gauge the real impact of the plan on shares in the years forward.

The company furthermore hiked its quarterly dividend by 22% to $0.28 per share, which will boost the annual dividend yield to 3.4%. The dividend hike came as a positive surprise as analysts were expecting a hike in the quarterly dividend to $0.26 per share.

Reduce The Pain For Microsoft Shareholders

The plans are much needed to attract dividend investors after shares of Microsoft have seen poor returns over the past decade. Excluding dividends, shares have risen merely 16% over the past decade, vastly underperforming compared to most of its competitors.

With the recent dividend hike, Microsoft is establishing itself as a dividend stock. It has been paying dividends for a decade now, and has steadily raised them over that time. The lack of capital gains, combined with the hikes, has boosted the current yield to attractive rates which approached the 3.5% mark at the time.

Implications For Other Technology Names

It is not just Microsoft which has large cash balances, as the growth over the past decade in the technology sector has resulted in swollen cash balances at many other technology names.

Even Apple (AAPL), which has seen its shares forty-folded over the past decade, felt the need to announce a $50 billion repurchase plan after shares were trading with losses of up to 35% compared to a year ago. While Apple's $50 billion repurchase plan might be bigger in absolute terms, it allows the firm to repurchase some 12% of the shares outstanding, compared to 15% for Microsoft. Its current dividend yield stands at 2.7%.

Google's (NASDAQ:GOOG) shares have seven-folded since its public offering. Yet the tech giant has not engaged in share repurchase or dividends, even though cash balances have swollen to $54 billion. Given the fact that shares are trading near all-time highs shareholders are not pressuring the company to return cash, as it has generated good returns historically.

Facebook (NASDAQ:FB) is a relative newcomer, being a public company for little over a year now. Given the early phase in the growth curve, and the relative "modest" cash position of $10 billion, the company has not initiated dividends or repurchased shares at this point.

Cisco Systems (NASDAQ:CSCO) which holds a $50 billion cash balance, has initiated its dividends in 2011, currently yielding 2.8% per annum, while also repurchasing at an aggressive pace.

Valuation

Microsoft ended its fiscal year of 2013 with $77.0 billion in cash, equivalents and short-term investments. The company operates with $15.6 billion in total debt, for a net cash position of roughly $61 billion.

Revenues for the year rose by 5.6% to $77.8 billion. Net income rose by 29% to $21.9 billion.

Trading around $33 per share, the market values Microsoft at $275 billion, or its operating assets at $214 billion. This values operating assets of the firm at 2.7 times annual revenues and 10 times annual earnings.

Investment Thesis

Note that the $40 billion share repurchase plan, although being immense, is not that much. For starters, it took Microsoft five years to complete the existing share plan, while the new plan does not even have an expiry date.

The $40 billion repurchase plan would amount to $8 billion per annum, if executed at the same pace as the previous one. Note that this is relatively modest to the $77 billion cash balances and $61 billion in net cash balances. Microsoft is expected to generate significant free cash flows in the coming years, even after accounting for the share repurchases and the recent dividend hike.

At the same time, the plan is a minor admittance of failure. Apparently Microsoft sees no better use of its cash than to return it to its shareholders. Yet this is not the time to complain about this.

Microsoft reported net earnings of $22 billion over the past year. The dividend hike to an annual $1.12 per share, for an annual dividend yield of 3.4%, cost the company some $9.5 billion per annum. Add to that a $40 billion share repurchase program, spread over 5 years, and investors receive another $8 billion per year, or a yield of 2.9%.

Combined, investors receive a yield of 6.3%, for a total payout ratio of 73% over last year's earnings. While the payout ratio is high, Microsoft is still accruing cash at a rate of $5 billion per annum, adding to the massive $61 billion net cash balances.

While the program is sizable, and dividend hike comes in above estimates of $0.26 per share, Microsoft maintains its financial flexibility for future deal-making activity or future dividend hikes, possibly even combined with special dividends.

For now, the "new deal" should place a foundation under Microsoft's shares for some time to come. Even at payout yields of up to 6.3% per annum to shareholders, the company keeps adding to its $61 billion net cash balances. Even if the new company might struggle to continue to grow revenues and earnings, the current high yield remains supportive to shares.

At least shareholders receive decent yields, while the company maintains financial flexibility to whether the operational challenges. While Microsoft is a true cash cow at the moment, the incoming CEO will have an immense task ahead to continue to provide for decent cash flows in the decade to come.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.