Microsoft, the Cash Cow

By DAVID MOON, Moon Capital Management
August 1, 2004

Last week, Microsoft announced it is going to distribute $75 billion of cash to shareholders, via a special dividend and share repurchases. The implications and lessons are numerous.

The first lesson of the special payout is the reminder that shareholders own the company, including all of its assets. If Microsoft distributes $75 billion to its shareholders, that will equate to about $7 a share. But when the announcement was made, the stock increased less than 50 cents. Why? Because the Microsoft shareholders already owned that $75 billion, whether it was distributed or not. When the shareholders eventually receive the $75 billion, they are merely being given an asset that is already theirs. In a perfectly efficient market, the stock will actually decline when the dividend is paid, reflecting this shift in ownership form.

If a person sells his house, then keeps the net proceeds in his bank account, he hasn't increased his net worth. He simply transferred the asset from one asset form (real estate) to another (cash.) The Microsoft dividend may put more cash in your pocket, but it only redistributes assets from a corporate form to a personal one.

But the most newsworthy observations from the Microsoft action are about the company's business. The Microsoft business model is incredibly profitable. The company generates over $10 billion a year in excess cash, even after paying all of its expenses, including significant research and development costs. Microsoft is a cash machine. It generates more cash per year than every drug company, automobile manufacturer and general retailer (including Wal-Mart) in the country combined.

But if we apply the business life cycle model to Microsoft, one has to wonder if it has reached its full maturation point, where it no longer has extraordinary growth prospects, but is merely a cash cow. If Microsoft is returning $75 billion to its shareholders, that means Bill Gates can't find anything attractive in which to invest. Don't you think he would continue to build his empire if he thought there was something he could buy or build or create with all of that cash? He doesn't need his part of the $75 billion distribution. He already committed to giving it to charity. I'm convinced this special distribution means Microsoft sees its growth opportunities dwindling, and that shareholders may have more profitable personal investment opportunities than does Microsoft.

It makes sense. The company is now so large that only a huge investment can make any impact on the Microsoft bottom line. There simply aren't many possible investments of that size.

The other problem is legal. Any sizable technology business Microsoft might buy would raise objection from antitrust regulators. Microsoft has enough resources to buy every PC and television manufacturer in the world. Do you think the government would allow that? What about broadcasting or cable TV? Nope, that's not going to happen.

If you own Microsoft, enjoy your special distribution. But don't expect the underlying business growth of the last twenty, or even ten years to continue.

David Moon is president of Moon Capital Management, a Knoxville-based investment management firm. This article originally appeared in the News Sentinel (Knoxville, TN).

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