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A little over two weeks ago, I wrote a piece on why Microsoft’s CEO needed to step down and how the company could drive shareholder value. This came immediately after Microsoft (NASDAQ:MSFT) decided to spend $8.5 billion to acquire Skype. Skype has 107 million users and under $1 billion in revenues and NO profits. Given Microsoft’s recent record of acquisitions, I am highly doubtful this one will ever increase shareholder value. Microsoft bought aQuantive for $6 billion in 2007 and then bid $48 Billion for Yahoo in 2008; hardly a stellar record. Regardless, Microsoft paid more than 50% more than anyone would have in my opinion for Skype. Obviously the company consistently does not use its $35 billion in net cash to best effect. So what could Microsoft have done to provide better value to its long-suffering shareholders who have had held a stock that has been dead money for over a decade?

  1. Use a little over $20 billion of its hoard to pay a special dividend of $2.50 a share. Since a major portion of Microsoft's cash is locked up overseas, it could finance part of distribution through low interest bonds, given its triple AAA balance sheet. Since its operating cash flow was over $24 billion last fiscal year and with the appetite for yield in the market; this would be a well-subscribed offering. It could also wait for a tax holiday to repatriate the funds, but the current political climate probably means this is off the table until 2013.

  2. Spend an extra $5 billion a year and double its dividend. This would give Microsoft a dividend yield of over 5%. Since the company basically functions much like a utility in many respects and this would only represent a payout ratio of 50%, this makes a lot of sense. It would also put a major price floor under the stock and attract a lot of value and dividend-seeking investors.

  3. Allocate an additional $6 billion to its stock buyback program. All things remaining equal this would take 2.5% to 3% more shares out of circulation each year, raise EPS, and put another floor under the stock.

  4. If Microsoft truly feels a need to make a major acquisition, may I suggest something to establish Microsoft in the smart phone market. No, I am not talking about Nokia (NYSE:NOK). Microsoft already knows how to fail in the U.S. Consumer Market (See Zune). I am thinking RIM (RIMM) here. The combination could make a lot of sense if Microsoft feels obligated to make a big splash with that cash hoard:

a. Microsoft could pay a 30%-35% premium and pick RIM up for $24 billion to $26 Billion. Since RIM is headquartered out of the country, I believe Microsoft would be able to use its overseas cash holdings without penalty.

b. This action would produce more earnings than the meager returns Microsoft is currently is getting on its cash holdings. Given RIM’s prodigious cash flow despite a shrinking market share, this would be immediately accretive to earnings to the tune of 30-40 cents a share.

c. Both companies are big players in the enterprise market. The merger of hardware and software could be compelling, produce significant synergies, and result in creating a major player in the smart phone market. I believe this would increase the amount of apps developers produce for Blackberries by a prodigious amount given the heft, tools and marketing weight behind this new combination.

d. I believe RIM’s management would be open to the merger as the company has to be becoming aware that it needs to make a game changing move to stop losing market share to the iPhone and Droid-powered phones.

  1. Go on an unprecedented talent buying spree to acquire established management expertise that better understands the consumer market. Microsoft could go after the top lieutenants at Amazon (NASDAQ:AMZN), Apple (NASDAQ:AAPL) and Salesforce.com (NYSE:CRM) that know they have no hope for the top jobs at their current companies. I would prefer Microsoft make a change at the top, but since that is seems unlikely; overpaying to get the management expertise it sorely lacks in the consumer market might not be a bad idea.

I think any one of these actions would add more value to Microsoft than buying Skype. Just my two cents.

Disclosure: I am long MSFT, AAPL.

Source: Microsoft: 5 Better Ways to Spend Its Cash Than Buying Skype