Commentary: Microsoft's $49 Billion "Problem"

By Jay Greene

Microsoft has a conundrum that any company would die for: what to do with its $49 billion pile of cash. With the stash amounting to $4.57 a share, it's what Goldman, Sachs & Co. analyst Richard G. Sherlund calls a "high-class problem."

Indeed, despite growing questions from investors about the size of the stockpile, Microsoft Corp. appears in no hurry to solve the dilemma. For now, the software giant has parked most of the money in conservative corporate and government notes and other short-term investments. "We pile it very nicely," Microsoft Chairman William H. Gates III jokes. "It's owned by shareholders. So we treat it very carefully."

Too carefully for some. With the cash growing at a rate of about $1 billion a month, some worry that Microsoft will waste the money on frivolous investments because the sum is so large. Larry J. Puglia, who manages the $6 billion T. Rowe Price Blue Chip Growth Fund, which owns about 10 million Microsoft shares, frets about the outfit "frittering away the money on investments that aren't well thought out."

Investors argue that Microsoft could better enhance shareholder value by raising its 8 cents-a-share dividend or by buying back shares. While execs said on July 24 that they would eventually take one or both of those actions, some argue it should happen sooner, not later. "We were disappointed they didn't increase the dividend substantially," Puglia says.

Moreover, the much-publicized $49 billion Microsoft reports as cash and equivalents is only part of the story. That figure includes cash and short-term investments -- held for a year or less -- as required under generally accepted accounting rules. As of June 30, Microsoft's total investment portfolio actually stood at $62.7 billion.

Microsoft's investment strategy is as conservative as its business practices are aggressive. About $9.2 billion is invested in cable companies, content providers, and other tech-related businesses. The rest, a chunk of some $53.5 billion, is in what Microsoft calls its nonstrategic treasury portfolio -- stocks and bonds in companies unrelated to Microsoft's core business, as well as government securities. About 70% of that goes to fixed-income investments, such as mortgage-backed securities, Treasury notes, and municipal bonds. Twenty percent is in cash and the final 10% in equities.

So how are Microsoft's investments doing? The company says its nonstrategic portfolio earned 7.5% last year and averaged annualized returns of 7.3% over the past three years. It did not disclose returns on the smaller strategic holdings. But overall, the company earned $1.6 billion -- about 16% of net income -- from investments in the just-ended fiscal year. Microsoft manages 75% of its investments. Professional money managers oversee the rest.

Not bad returns, but the question remains: Does Microsoft really need so much cash? Execs say it's an insurance policy against remaining litigation, including two biggies: the antitrust probe by the European Union and a private suit by rival Sun Microsystems (SUNW ) Inc. And while the software giant doesn't talk about it, the cash offers a huge competitive advantage, letting Microsoft enter new markets and endure losses until it gains a foothold. Case in point: the Xbox game console and the MSN online business.

But $49 billion is far more than it needs. The maximum financial damage from the two cases comes to about $6.2 billion. EU regulators can fine antitrust violators up to 10% of the previous year's revenue, or $3.2 billion based on Microsoft's just-ended fiscal year. Sun has said damages could hit $1 billion, which can be trebled under federal law.

Hence analysts and investors figure the company could trim its cash holdings to $30 billion and have all the financial flexibility it needs. Many favor a major stock buyback, as well as an increased dividend. Both moves would transfer the money to shareholders by bolstering the stock price. With shares virtually flat this year compared with the Merrill Lynch (MER ) 100 Tech index's 34% gain, Microsoft could turn this "problem" into opportunity.

Greene covers Microsoft from Seattle.

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