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Does Microsoft Still Deserve a "AAA" Rating? (MSFT, GOOG, AAPL, YHOO)

Microsoft Corporation (NASDAQ: MSFT) closed lower today along with many technology companies, but there is something rather interesting worth noting.  This morning we covered a small esoteric convertible debt offering of $1.15 billion coming from the company.  This is debt that looks to repay other maturing debt, so it is a non-event when you consider its $200+ billion market cap.  And it is also irrelevant that S&P assigned a “AAA” rating on the surface because this was merely a ratings assignment to debt that was just replacing debt.  But after giving this a further look and considering the dominance of Google Inc. (NASDAQ: GOOG) and Apple Inc. (NASDAQ: AAPL), one real and serious question comes to mind for the second decade of the 21st century. … Does Microsoft really still deserve its Triple-A rating without question?

You know part of the drill here.  Google Inc. (NASDAQ: GOOG) now dominates online search.  It dominates web video, it is the content aggregator and online advertising beast of the world.  And it has many free software angles and now an operating system angle via Android that can attack the Windows and Office bastions of strength.  And everything outside of Microsoft’s core business has effectively been deemed a tarball.

And speaking of O/S and software issues, Apple Inc. (NASDAQ: AAPL) has continued to keep coming up with hit after hit.  At first it was iTunes, a massive killer of the Zune.  And those pesky Mac sales actually turned into a real powerhouse as well taking a larger piece of the operating system pie.  And the iPhone and then the iPad, let’s just say that Microsoft didn’t even beat the Jamaican bobsled team on Windows Mobile and let’s also say that Bill Gates’ big screen table with a touchscreen top that was demonstrated long ago did not do anything for the company except maybe give Steve Jobs the idea that one of those could be put in your lap.  Fortunately, that Parallels program still allows Windows to be sold on some Macs and Office can be run on Mac.

And as far as the Yahoo! Inc. (NASDAQ: YHOO) search pact?  The jury is still out as to whether that will be a win or not.  Steve Ballmer at first wanted to acquire Yahoo! and that would have almost certainly put a crimp on Microsoft’s cash and would have certainly dragged the company down during the great recession.  Besides, now Microsoft got a huge part of the business it wanted almost for only sharing in upside compared to an acquisition.

So what does S&P say for itself in the affirmation of that “AAA” rating.  Keep in mind that this was effectively nothing more than a mere mechanical call as the rating went from one small maturity to another.  Still, we want to know if Microsoft actually still deserves this “AAA” rating…

S&P affirmed its ‘AAA’ corporate credit rating and ‘A-1+’ short-term and CP ratings on Microsoft.  It gave a stable outlook as well, meaning no real review is out for a downgrade.  The stable outlook reflects S&P’s expectation that the software giant will “maintain very modest leverage and a commitment to the highest level of credit quality, coupled with a conservative strategy of largely organic growth.”

The call reflects S&P’s notion of Microsoft’s excellent operating performance and financial profile as it maintains “a vertically integrated and diverse product portfolio with numerous leadership positions, a broad geographic footprint, and minimal financial risk.”

S&P’s Philip Schrank also said, “While we view the high-technology industry as having higher-than-average business risk, we regard software companies more favorably because of the recurring nature of the business, significant barriers to entry, and strong cash flow generation.”

There is just one small problem here, even though unseating Microsoft is probably something that cannot even be done in the course of an entire decade.  If more and more Apple Macs, Apple iPod, Apple iPads, Apple iTunes songs, Blckberry R-I-M phones, Android O/S smart phones, Linux-based PCs, and ultimately Android O/S as a challenge for the PC market… That Windows dominance suddenly is not immune.  The good news is that Microsoft still has what many would call a virtual monopoly on the corporate, enterprise, and business-side of the equation.  With virtualization, could that become a risk?  That depends on far too many factors to aim all at once.

What Microsoft has going for it is a steady cash flow.  Its profits are immense, and would likely have far higher overall margins if it was not bogged down in other operations.  It is sitting on a mountain of cash, valued at $39.666 billion at the end of last quarter.

Microsoft has never even come close to losing money in a quarter on operations.  It continues to add cash, and it has enough of an arsenal that it could shrink down its float easily or pay one hell of a dividend while the tax rates are still low in 2010.

After looking at everything here, Microsoft’s Triple-A rating is safe for some time to come.  Yet what is interesting is that the relative position to peers and the dominance over peers of the past is changing.  And that change feels rapid in career terms even if it seems slow in annual terms.

As my old friend Doug from the Chicago Federal Reserve said a few years ago (2004) when Microsoft paid out a $3.00 special cash dividend, “Microsoft is no longer a great growth story.  It is now a utility.”

Maybe being a utility is OK.  As long as the company dominates its software space and as long as it keeps cranking out profits in this manner, that Triple-A rating will remain even if the stock stays dead money.

JON C. OGG

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