CASE STUDY 2 Microsoft Solving a Good Problem for a Company to Have (2004) Strategic Overview Microsoft announced at the annual shareholders meeting in November 2002 that, despite having $40 billion in cash on its balance sheet, the company would not be taking any substantive measures to distribute the cash to its roughly 4.2 billion shareholders. Microsoft stated that the cash was needed to satisfy judgments that could arise from ongoing corporate and private antitrust lawsuits. While the company had a history of buying back its stock, Microsoft had never paid a dividend since going public in 1986. The no dividend policy made sense historically as high-tech, growth companies with high P/E's, typically don't issue dividends, but instead elect to plow their profits back into the business. But as of the shareholder meeting, Microsoft's growth had slowed to Options Management was under pressure to act. They could choose between a myriad of options including: 1) Doing nothing, 2) Using the cash to finance acquisitions and expansion, 3) Returning the cash to shareholders by beeting-up the ongoing stock repurchase program, a program that had the company buying back shares at the rate of up to $ 6 billion a quarter, or 4) Retuming cash to shareholders by issuing about 10 percent annually, from 30 percent or more in the company's early years, and the stock, as evidenced by its inclusion in the Dow Jones Industrial Average, had begun to look more like a stable blue chip than a high-flying tech issue. The announcement made at the 2002 meeting angered many shareholders. Growth had stagnated and the company was sitting on a pot of cash. It was an efficient business that was generating $1 billion a month in free cash. In a shrinking interest rate environment, Microsoft's returns on short term investments were insignificant and reduced the firm's return on equity. The state of affairs led one investor at the meeting to comment, "We need a reason to hold the stock. We need a dividend. We need something." dividends. Given the company had virtually no debt (see below), share repurchase appeared to be an efficient way to solve the problem. Buybacks are tax efficient to individual investors and protect shares from dilution due to option exercise. Unlike repurchases, investors assume that dividends payments, once begun, will continue indefinitely Decision In mid-January of 2003, three months after community by announcing its first-ever the November 2002 shareholder meeting, annual cash dividend of 8 cents per share (2 the company surprised the investment cents per quarter). The dividend represented Bierman, H. (2017). Case studies for corporate finances from A (Anheuser) to Z (Zype) (Vol. 1). World Scientific a total outlay of more than $850 million which translated into just over a quarter of 1 percent of the share price. While the dividend made big news, it was met with criticism that the dollar amount was insignificant Following the announcement speculation immediately arose over Microsoft's change in philosophy. One suggested reason for the dividend was President Bush proposed tax reform plan which would exempt shareholders from income tax on dividends (later changed to a 0.15 tax rate). Another possible reason, and the one that Microsoft stated publicly, is that many of the company's legal risks are largely behind them. The company settled with the Justice Department and many private antitrust claimants and has made progress with the European Union Shareholder Reaction and Company Update Microsoft's stock price dropped about $4 or would issue a special cash dividend of $3 7% the day following the dividend per share payable on December 2, 2004. announcement. This was partially With almost 11 billion shares outstanding. attributable to the relatively weak outlook the special dividend would return almost for the current quarters, but the falling price $33 billion in cash to shareholders. In July, was likely an indication that some investors the company also announced that it would concluded that Microsoft had exhausted its begin to pay a regular quarterly dividend of growth options and the future looked $0.08 per quarter. The move represented a uncertain. doubling of the dividend - the second time Despite the dividend payments and despite the dividend had doubled since the initial continued stock buyback, Microsoft dividend issuance. But even with the latest continued to increase its cash balance. In doubling, Microsoft's yield will still be July of 2004, the company announced it below the 1.7% average yield for the S&P 500. Questions 1. Was the decision to start paying a cash dividend of $0.02 per share per quarter a good decision? Why or why not? 2. Was the $3 per share special dividend desirable? Why or why not? 3. What were Bill Gates' proceeds as part of the $3 per share special dividend? What did he do with those proceeds? Did the size of his proceeds cause investor backlash? Should companies consider this when choosing to pay dividends or special dividends? Why or why not? 4. What, if anything, should Microsoft have done with its $64 billion of cash and short-term investments? 5. Analyze and describe Microsoft's dividend policy as it exists today. Do you agree with the firm's dividend policy? Why or why not? What, if anything, should Microsoft do differently with its extra cash and why? Bierman, H. (2017). Case studies for corporate finances from 4. (Anhener) to Z (Zype) Vol. 1), World Scientific CASE STUDY 2 Microsoft Solving a Good Problem for a Company to Have (2004) Strategic Overview Microsoft announced at the annual shareholders meeting in November 2002 that, despite having $40 billion in cash on its balance sheet, the company would not be taking any substantive measures to distribute the cash to its roughly 4.2 billion shareholders. Microsoft stated that the cash was needed to satisfy judgments that could arise from ongoing corporate and private antitrust lawsuits. While the company had a history of buying back its stock, Microsoft had never paid a dividend since going public in 1986. The no dividend policy made sense historically as high-tech, growth companies with high P/E's, typically don't issue dividends, but instead elect to plow their profits back into the business. But as of the shareholder meeting, Microsoft's growth had slowed to Options Management was under pressure to act. They could choose between a myriad of options including: 1) Doing nothing, 2) Using the cash to finance acquisitions and expansion, 3) Returning the cash to shareholders by beeting-up the ongoing stock repurchase program, a program that had the company buying back shares at the rate of up to $ 6 billion a quarter, or 4) Retuming cash to shareholders by issuing about 10 percent annually, from 30 percent or more in the company's early years, and the stock, as evidenced by its inclusion in the Dow Jones Industrial Average, had begun to look more like a stable blue chip than a high-flying tech issue. The announcement made at the 2002 meeting angered many shareholders. Growth had stagnated and the company was sitting on a pot of cash. It was an efficient business that was generating $1 billion a month in free cash. In a shrinking interest rate environment, Microsoft's returns on short term investments were insignificant and reduced the firm's return on equity. The state of affairs led one investor at the meeting to comment, "We need a reason to hold the stock. We need a dividend. We need something." dividends. Given the company had virtually no debt (see below), share repurchase appeared to be an efficient way to solve the problem. Buybacks are tax efficient to individual investors and protect shares from dilution due to option exercise. Unlike repurchases, investors assume that dividends payments, once begun, will continue indefinitely Decision In mid-January of 2003, three months after community by announcing its first-ever the November 2002 shareholder meeting, annual cash dividend of 8 cents per share (2 the company surprised the investment cents per quarter). The dividend represented Bierman, H. (2017). Case studies for corporate finances from A (Anheuser) to Z (Zype) (Vol. 1). World Scientific a total outlay of more than $850 million which translated into just over a quarter of 1 percent of the share price. While the dividend made big news, it was met with criticism that the dollar amount was insignificant Following the announcement speculation immediately arose over Microsoft's change in philosophy. One suggested reason for the dividend was President Bush proposed tax reform plan which would exempt shareholders from income tax on dividends (later changed to a 0.15 tax rate). Another possible reason, and the one that Microsoft stated publicly, is that many of the company's legal risks are largely behind them. The company settled with the Justice Department and many private antitrust claimants and has made progress with the European Union Shareholder Reaction and Company Update Microsoft's stock price dropped about $4 or would issue a special cash dividend of $3 7% the day following the dividend per share payable on December 2, 2004. announcement. This was partially With almost 11 billion shares outstanding. attributable to the relatively weak outlook the special dividend would return almost for the current quarters, but the falling price $33 billion in cash to shareholders. In July, was likely an indication that some investors the company also announced that it would concluded that Microsoft had exhausted its begin to pay a regular quarterly dividend of growth options and the future looked $0.08 per quarter. The move represented a uncertain. doubling of the dividend - the second time Despite the dividend payments and despite the dividend had doubled since the initial continued stock buyback, Microsoft dividend issuance. But even with the latest continued to increase its cash balance. In doubling, Microsoft's yield will still be July of 2004, the company announced it below the 1.7% average yield for the S&P 500. Questions 1. Was the decision to start paying a cash dividend of $0.02 per share per quarter a good decision? Why or why not? 2. Was the $3 per share special dividend desirable? Why or why not? 3. What were Bill Gates' proceeds as part of the $3 per share special dividend? What did he do with those proceeds? Did the size of his proceeds cause investor backlash? Should companies consider this when choosing to pay dividends or special dividends? Why or why not? 4. What, if anything, should Microsoft have done with its $64 billion of cash and short-term investments? 5. Analyze and describe Microsoft's dividend policy as it exists today. Do you agree with the firm's dividend policy? Why or why not? What, if anything, should Microsoft do differently with its extra cash and why? Bierman, H. (2017). Case studies for corporate finances from 4. (Anhener) to Z (Zype) Vol. 1), World Scientific