Microsoft’s Dividend Hike Not A Bold Move (MSFT, GOOG, VMW)

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Last night Microsoft (NASDAQ:MSFT) announced that it was boosting its quarterly dividend from $0.10 to $0.11.  The dividend is payable December 13, 2007 to shareholders of record on November 15, 2007, and the ex-dividend date will be November 13, 2007.  Microsoft shares are up 0.35% after the open, about half of the gains in the broad market.

Raised dividends are usually a good thing, but it also shows the stage that the software giant has entered and we’d rather see more ‘special dividends’ rather than a small incremental boost.  If you have read our take on things, you’ll know that this move is one we don’t have the world’s greatest opinion of.  The classical investing model shows that raised dividends lead to higher stock prices, but it also shows that Microsoft is farther and farther away from being a growth stock.  I have even hijacked a phrase "Microsoft isn’t a major growth company anymore, it’s a utility stock!" from a friend of mine at the Federal Reserve.  But we still think it can take a path that leads to higher share prices.

If Microsoft wants to be impressive on its dividend, it should hoard cash and pay these special dividends.  At the end of 2004, the software giant paid out a $3.00 special dividend.  Shares actually traded flat and lower for basically a year after that special dividend, but in the longer-term shares reached over $31.00 earlier this year.  The truth is that the two are unrelated.  The tie isn’t even relevant.  But this is the best way of returning cash to shareholders in what is currently a most tax efficient manner.  We don’t know if the dividend taxes or capital gains taxes will really go up after 2008 or not, but depending on election results there could be some big changes there.

As of June 30, Microsoft held $23.4 Billion in cash and short-term investments.  It also held over $10 Billion in longer-term investments, part of which are stocks in other large public companies.  It holds $8.3 Billion carried under ‘other’ and long-term debt, and its other $23.75 Billion in liabilities are all day to day operations.  After this, you have to back out the $6 Billion or so that the company paid for aQuantive that closed in August.

The company can do share buybacks, but with the size and average daily trading volume it just requires too much capital spent for it to make much sense.  Microsoft has roughly 8 Billion shares in the float and has 9.375 Billion shares outstanding.  If you do the math and do the projections out there for its earnings this year and next, the company could do a serious return of capital.  If investors know that every other year they might receive a $1.00 or higher special dividend they might get more excited than if they receive the $0.11 every quarter instead of the $0.10 previously.  The company should consider this for later in 2008.

The only reason the company wouldn’t want to do this is if wants to go make more and more multi-billion dollar acquisitions like aQuantive.  If it wants to do that, then all bets are off.  This special dividend versus a slight hike in a low normal dividend is also purely a matter of opinion.  Microsoft has been hampered by the likes of Google (NASDAQ:GOOG) and others, and the new virtualization efforts from it and VMware (NYSE:VMW) are going to end up being a mere footnote on a relative basis to Microsoft’s size for the next 12 to 18 months.  We also saw some of the plans in May for a post-Gates era.

We still think Microsoft can reach the mid-$30’s over the next 12 months if it can execute on its many initiatives, and the downside seems less than than the upside at current levels.  The problem is that we had the same viewpoint back in January when we laid out the path that could take Microsoft shares to $36.00.  A myriad of things can change that, and the calendar and upcoming industry trends will determine which side of the crystal ball is accurate.

Jon C. Ogg
September 13, 2007

Jon Ogg can be reached at jonogg@247wallst.com; he produces the 24/7 Wall St. Special Situation Investing Newsletter and he does not own securities in the companies he covers.