Microsoft's New, Improved Spending

The software maker gave investors something to smile about: a plan to buy back $40 billion in shares and an upbeat forecast

What a difference three months can make for Microsoft. A quarter ago, as it announced earnings, the software maker caught investors unawares with news of an increase in investment spending.

On July 20, Microsoft (MSFT) had another surprise up its sleeve, again having to do with spending. But this one left shareholders decidedly more pleased. In announcing fourth-quarter results, Microsoft said it will buy back $40 billion in stock, having just completed a $30 billion buyback over the last two years.

Redmond's pleasant surprises didn't end there. Quarterly revenue climbed 16%, to $11.8 billion, beating analysts' forecasts for sales of $11.6 billion. And earnings per share, excluding legal charges, were 31 cents, exceeding analysts' estimates by a penny. The results, coupled with the repurchase plan and an upbeat forecast for the current fiscal year, sent Microsoft shares climbing in extended trading. The stock rose $1.28, or 5.6 percent, to $24.13.

Investors have pressed Microsoft to use its huge cash hoard—$34.2 billion as of June 30—to boost share value. The stock is off 14% since the beginning of the year and well off its peak from a half-decade ago.


  The buyback will include a $20 billion tender offer to acquire 808 million shares, or 8.1% of its outstanding stock. The tender will take the form of a reverse Dutch auction that lets shareholders choose how many shares they want to sell, and at what prices, as long as it's between $22.50 and $24.75 a share. Shareholders have until August 17 to tender their stock. Microsoft will then determine the lowest price per share that will enable it to buy the 808 million shares.

The repurchase will more than halve the company's cash holdings, leaving them roughly where they were eight years ago. The company's cash, though, continues to grow by about $1 billion each month. So Microsoft also announced plans to buy back another $20 billion of its stock by June 30, 2011.

Two years ago, Microsoft said it would repurchase $30 billion of stock over four years, in addition to a one-time, $3-a-share dividend, equal to $32 billion (see, 7/21/04, "Dollars Finally Rain from Redmond"). The company just completed that buyback, two years ahead of schedule.

Results were again fueled by sales of Microsoft's server software. Sales in the server and tools division were $3.2 billion, topping sales from the company's information worker group that includes its Office desktop software. The big gains came from sales of its SQL Server database software, which grew 35% in the quarter. The group's operating income hit $1.2 billion, up 53%.


  More good news came from the division that focuses on gaming consoles. Microsoft said it has overcome the Xbox 360 shortage problems that had plagued sales of the console in the first few months after its Nov. 22 launch (see, 1/27/06, "Microsoft's News of Many Parts"). In the last quarter, Microsoft added a third contract manufacturer to ease the crunch. As a result, it sold 1.8 million consoles in the period and said the shortage was behind it. Revenue in the home and entertainment group climbed 94%, to $1.1 billion. Operating losses more than doubled, to $414 million—a reflection that video-game consoles typically are sold at a loss early in the product cycle, with hopes of making money later on licensing from video-game sales.

The solid quarter helped Microsoft get back to double-digit growth, after posting 8% revenue gain in the previous fiscal year. In fiscal 2006, sales grew 11%, to $44.3 billion, on operating income of $16.5 billion, a 13% gain. "The fourth quarter was a strong close to a good year," Microsoft Chief Financial Officer Chris Liddell said on a conference call with analysts, investors, and reporters. For the fiscal year just starting, Microsoft is calling for sales of $49.7 billion to $50.7 billion, implying an increase of 12% to 14%.

It was an altogether different story on the earnings call just three months ago. Then, Microsoft jolted Wall Street with news it would spend roughly $2.5 billion more than analysts expected. (see, 4/28/06, "Microsoft's Strange Spending Splurge"). The company offered little explanation of how it planned to spend the money, and its shares tanked as a result.


  On this call, Liddell gave more detail on plans for spending the money, which now amounts to about $2.7 billion in the current fiscal year. About $450 million will go toward marketing and launch costs for a host of new products, including new versions of its Windows operating system and Office. Another $450 million will be used to hire sales staff and to boost marketing efforts for existing products. Microsoft plans to spend $1 billion developing new products and services in high-growth markets and another $500 million focusing on its Web services push. The last $300 million will cover general increases in costs and possible acquisitions.

Analysts came away with a better outlook toward Microsoft than they've had in a long while. "This is a company that's taken its lumps from investors," says Sanford Bernstein analyst Charles DiBona. But the company responded, giving investors much of what they wanted—a stock buyback. What's more, the company opened up a little bit, sharing information that was lacking in the previous earning release. In sum, DiBona says, "the tone was really good."

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