Microsoft's Lonely Dividend Bandwagon
By Amey Stone
At first glance, Microsoft's decision to begin issuing a dividend seemed to be a strong endorsement for President George W. Bush's plan to eliminate taxation of dividend payments. Just as Democratic and moderate Republican leaders were starting to question whether the move could stimulate the economy, Microsoft's Jan. 16 announcement seemed to indicate it already was. Without so much as a congressional vote in the capital, it appeared as though Bush's plan had freed up some $860 million in cash Microsoft might otherwise have sat on. And it made sense to assume that this could put pressure on more tech companies to follow suit.
Increasingly, though, that seems less likely. Microsoft (MSFT ) had plenty of good reasons to issue a dividend, albeit a small one relative to its earnings base, before Bush's tax plan came along. And with Microsoft shares down 12%, to $49, since the announcement, it sure looks as though tech investors aren't clamoring for dividends. Most important, precious few tech concerns could issue a dividend, even if they wanted to.
"Technology companies will certainly be reexamining the issue," says Chuck Carlson, editor of the stock-dividend plan investment newsletter, DRIP Investor. "But once you get past the Dells, Ciscos, and Oracles of the world, the list of candidates shrinks pretty quickly." Other profitable, cash-rich tech leaders like IBM (IBM ), Hewlett-Packard (HPQ ), and Intel (INTC ) already pay a dividend -- all without much fanfare and with a significantly higher yield than Microsoft is offering.
Beyond a handful of giants, not too many tech businesses have either the steady profits or the cash stake to comfortably disburse earnings to shareholders so long as the sector is flat on its back. Tech spending is forecasted to pick up in 2004, but no hard evidence shows that it will. Look no further than Sun Microsystems (SUNW ) -- at $3.25 a share, down 95% from its September, 2000, peak -- for an example of why it's smart for tech concerns to build up cash stakes in good times. After losing about $2 billion in calendar year 2002, Sun will need every cent of its $5 billion in cash to retool and stay competitive as its server business languishes.
Even when tech spending rebounds, most of the sector's outfits will be in growth mode and throw any cash they generate back into the business as fast as they make it, says Jeff Greiner, managing director at RBC Capital Markets. That's what tech investors want them to do, according to Peter Cohan, an investment strategist and author in Marlborough, Mass.
Another reason tech CEOs might be discouraged from making the same move is investor reaction. The dividend announcement hardly stabilized Microsoft's stock. The price fell nearly $4, or 7%, the day following the Jan. 16 announcement.
That may have been mostly because management's outlook for the current quarter was weak, but it's also likely that some investors saw the dividend as a sign that Microsoft had run out of options for growth, says Don Luskin, chief investment officer at research boutique Trend Macrolytics. "The risk is that paying a dividend could signal that tech has matured and is no longer the racy growth sector it once was," says Paul Shread, an analyst at Internet.com.
Given the risks, the incentive to offer a tax-free dividend just isn't that strong, says Cohan. Corporate finance chiefs have almost as strong an incentive under the plan to retain any earnings, which could provide taxpayers with a capital-gains tax break.
In all fairness, Microsoft had a unique set of circumstances that may have led to its decision. It has huge insider ownership, and if Bush's proposal makes it into law, management will be rewarded handsomely. Bill Gates would reap nearly $100 million tax-free if the plan passes. Chief Executive Steve Ballmer would gain $40 million tax-free from the move. "It's a great way for insiders to get cash out of the business without having to signal to the market that they're selling," says Cohan.
That's not the reason Microsoft cited when explaining its decision. In its conference call, executives said they felt comfortable issuing the dividend because many of Gates & Co.'s legal risks were mostly behind it now that it has settled the Justice Dept.'s landmark antitrust case. That's definitely unique to the software giant. Indeed, some experts tie the settlement to Microsoft's timing the dividend announcement to come just as criticism of Bush's plan was picking up speed. "Microsoft's move may have been motivated by the need to support the Bush Administration, which has been supportive of Microsoft," says Shread.
So far the software giant hasn't publicly responded to speculation about the timing or motivation. And Microsoft may have decided to issue a dividend even without Bush's tax proposal. Many of its shareholders had been after it for a long time to send some cash their way. Microsoft's pile of cash had mounted to a staggering $43 billion, and it was struggling to find compelling growth businesses to invest all of it in, says Luskin.
A few other tech companies may jump follow Microsoft. But even if the Bush plan becomes law in mid-2003 and two or three times as many tech companies ultimately decide to pass along dividends, this won't mean significant payouts for investors, says Greiner. That's partly because the increase is off a very small base, and of those that may eventually offer dividends, he says, "I don't think any of them are ever going to become among the highest-yielding stocks out there."
In the long run, if the Bush plan passes and only the strongest companies are able to issue dividends, having a tax-free payout could eventually become an important sign of quality that even tech investors look for. For now, however, Microsoft's decision to issue a dividend won't do much on its own to nudge other tech outfits into doing the same thing. And for most investors in the downtrodden sector, that's probably just as well.
Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column
Edited by Beth Belton
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