Microsoft's Dutch Treat For New Investors

| About: Microsoft Corporation (MSFT)
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Investopedia Advisor submits: A somewhat better than expected quarterly result and the surprise announcement of a major share buyback gave Microsoft (NASDAQ:MSFT) shares a lift in trading on Friday. However, there are a number reasons to believe that there is enough value still on the table to be of interest to U.S. investors.

Friday's share price jump is largely a response to the company’s just-announced US $40 billion share-buyback program. The first part of the program involves $20 billion and is based on the Dutch Auction process, which works like this: For a period starting July 21 and ending August 17, Microsoft shareholders will be able to tender all or some of their shares indicating a price they wish to receive.

The price ranges between US $22.50 and $24.75. As a Dutch Auction works in reverse to a normal auction, with the lower requested price shares being taken up first, shareholders tendering at the lower end of the price range increase the odds of having their shares taken up.

As the market price has now moved to $24, it’s now logical that people tender at the high end of the range.

Assuming all the shares tendered are taken-up at US $24.75, 808 million shares, or about 8% of the shares outstanding should be absorbed under the offer. The second tranche of the buyback will be of a more traditional nature and extend out to 2011. With a cash horde of US $34 billion on hand, Microsoft obviously felt that it could afford putting $20 billion back into the hands of its shareholders in an effort to put a floor under the share price.

Given the 22% plunge experienced by Yahoo! (YHOO) a couple a days ago, the move provides a much needed psychological boost to shell-shocked tech investors, who have suffered an almost uninterrupted 15% decline in sector valuations since early April.

Will the company’s investment in itself pay off? Judging by the just released quarterly numbers (4th quarter ending June 30th for fiscal 2006), there are some signs that the time may be right to take a more positive view on the company. While the EPS result of $0.31 was just a penny higher than Street consensus, and still locked in the US $0.26 to $0.33 range that has prevailed over the last two years, one has to look at the revenue numbers to see some encouraging trends.

For the whole year, revenues were up 16%, with solid gains in six of the company’s seven business segments. Bookings were strong during the quarter, showing growth of 25% year-over-year and unearned revenues were up 19%. This last item, which primarily reflects license renewals, suggests that Microsoft should see good numbers out of the release of its long delayed Vista operating system and the latest version of Office 2007, scheduled to make their debut this fall.

However, not every item in the results was peaches and cream. Last quarter’s surprise announcement that expenses would be $2 billion higher than Street consensus (which prompted the stock’s own little one day 11% proverbial plunge over Niagara Falls last April) doesn’t look like it will reverse trend anytime soon.

In the race to stay competitive with arch-rival Google (NASDAQ:GOOG), Microsoft is investing heavily in its new advertising platform, MSN Adcenter, a critical element in recovering ad revenue lost to Google. The company’s core packaged software business should also see costs rise and margins decline as a result of higher R&D and S&M (Selling and Marketing) costs related to critical new product launches like Vista and Office 2007.

Wrestling a viable slice of the lucrative gaming business away from Sony (NYSE:SNE), by spending aggressively on the Xbox 360 game console, will also not come cheaply.

All this is clearly a sign of the times for Microsoft, which faces increased competition on a number of fronts. Investors looking at the shares at this juncture have to ask themselves whether these higher charges represent the current cost of doing business, or investments in future new product growth opportunities. If you’re of the latter opinion, you have to take a longer-term view on the stock.

With the current Dutch Auction buy-back providing a free at-the-money put at current market prices, an investor could step into a the long term position now, with the added sweetener of a little short-term insurance should the market take another one on the chin brought on by the increasingly unpredictable events taking place in the Middle East right now.

By Eugene Bukoveczky, Contributor - Investopedia Advisor