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January 2, 2002

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Heard on the Street

A Cash-Rich Microsoft Faces

Shareholder Call for Dividend

By REBECCA BUCKMAN

Staff Reporter of THE WALL STREET JOURNAL

It is tough out there in the technology business, with sales tanking and once-hot start-ups closing up shop. Then there is Microsoft, sitting atop $36 billion in cash and short-term securities.

That's right, $36 billion. Its legal woes and recent investment losses aside, the Redmond, Wash., software company is an enviable cash machine -- and that has some investors and analysts urging Microsoft to stop hoarding its pennies and give more of them back to shareholders. In other words, they say, Microsoft should concede it isn't growing as fast as it used to -- and go the way of Old Economy stalwarts like General Electric, which pays shareholders a dividend. The analysts proffer the same advice to Microsoft's cash-rich technology cousins, such as Cisco Systems and Oracle.

In the past, stock dividends have been heresy to technology highfliers like Microsoft, which worried that making a quarterly payout to shareholders would brand them as old and stodgy, instead of nimble and fast-growing. Microsoft Chief Executive Steve Ballmer "historically has said no way" to the idea of a dividend, notes Paul Dravis, a fund manager for Dresdner RCM Global Investors in San Francisco.

The $36 billion on hand at Microsoft as of Sept. 30, the latest figure available, far surpasses the cash on the balance sheet of any other U.S. corporation, analysts say. GE counts about $8.8 billion in cash and equivalents, while International Business Machines has just over $4 billion. Microsoft's hoard can't simply be "a rainy-day fund," says Patrick McGurn, a vice president at Institutional Shareholder Services, which advises institutional investors on various issues. "Because if it is, then they're expecting something along the lines of Noah."

So barring a 40-day flood, Microsoft has lots of options. For instance, it could use the money for acquisitions or investments. But "acquisitions have traditionally not been a major use of cash" by Microsoft, notes Rick Sherlund, an analyst with Goldman Sachs. Instead, Microsoft generally buys small rivals and then builds new businesses itself, although it did spend about $1 billion to purchase Great Plains Software last year. Microsoft also recently offered to pony up extra cash to help two big cable companiesbuy AT&T's vast cable business, though it wound up simply agreeing to convert $5 billion of existing, preferred stock into shares of the new ATT Comcast.

Microsoft might also want to conserve some cash to pay legal fines in its continuing antitrust battles. Microsoft could face a hefty fine from the European Union as early as this spring, and the company also plans to dip into its reserves to settle private antitrust suits brought by U.S. plaintiffs. A current plan to settle those cases, which still must be approved by a federal judge, calls for Microsoft to donate $1 billion in grants, software and other services to poor U.S. schools. (Microsoft balked recently when the judge overseeing those cases suggested Microsoft simply donate $1 billion in cash. Company officials said schools would get more value out of software, though some critics question the dollar figure Microsoft places on programs that cost it little to produce.) Asked about the possibility of issuing a dividend, a Microsoft spokeswoman says, "It's something that [the] board considers from time to time." But traditionally, the company has opted to reinvest its cash back into its business, she notes, as well as buy back its own stock to offset the share dilution caused by its huge employee stock-option program. In its last fiscal year, ended June 30, Microsoft spent just over $6 billion on stock buybacks.

Oracle, too, says it believes "it is in the best interest of stockholders to reinvest our earnings into the future of the company," according to a company spokeswoman. Representatives from Oracle and Cisco say the companies have no plans to start issuing dividends.

But Microsoft, at least, likely has more than enough cash to fund stock buybacks, research and development and a host of other programs-and still have billions left over.

Companies like Microsoft are "cash machines" that are "maturing," says Steve Milunovich, Merrill Lynch's top technology strategist, in a research piece published last month that says it may be time for tech firms like Microsoft to consider dividends.

Money at Microsoft builds up so fast because profit from the company's core, market-dominating Windows and Office products far surpasses the costs needed to create and manufacture new versions of the software, since the basic architecture of the products already exists. These days, Microsoft is more or less "stamping out [software CDs] at two cents a disc," Mr. Milunovich says. The interest and dividends earned on Microsoft's cash pile now represent about 19% of operating income, the company says.

Indeed, the company is generating about $1 billion in free cash flow a month, meaning it could have $48 billion in cash in a year, says Mr. Sherlund, the Goldman analyst. "I mean, how much cash do you need?" marvels Mr. Sherlund, who agrees that Microsoft should probably do something else with the money.

Paying a dividend could be an efficient use of excess capital, Mr. Milunovich and other maintain. There are few investments Microsoft can make that will match the huge profit margins of its core desktop-software business, which created the cash hoard in the first place. "It's hard to replicate 90% gross margins," says Tom Rath, a portfolio manager and analyst at Safeco Asset Management in Seattle. "That's why returning the money to shareholders makes sense."

Microsoft also likely doesn't have the management breadth to oversee many more new businesses, now that it is already dabbling in everything from video games to television, analysts say. The company's recent track record with big investments isn't so great, either. For the last two successive quarters, Microsoft has taken huge charges to write down the value of poorly performing investments, most of them telecommunications, cable and Internet stocks. The write-down in Microsoft's fiscal fourth quarter, ended June 30, slashed the company's quarterly earnings to just a penny a share.

Mr. Milunovich argues that dividends could attract certain new investors, including more-conservative pension funds and insurance companies. He does acknowledge that two of the three major technology firms that began issuing dividends over the past 20 years, after having a no-dividend policy, did see some contraction of their price-to-earnings stock-trading multiples relative to competitors. Though that statistic might reinforce Microsoft's fears about forging ahead with a dividend, Mr. Milunovich says other factors could have caused the contraction.

The bottom line: "Does Microsoft really need $36 billion in cash and growing?" he writes in his report. "Once the government [antitrust] suits are behind for certain, we think the answer is no."

Write to Rebecca Buckman at rebecca.buckman@wsj.com

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