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Microsoft Plumbs Yield Depths With AAA Issue: Corporate Finance

November 05, 2012

Microsoft Plumbs Yield Depths With AAA Issue

Microsoft is responding with the release of its first computer hardware device, the Surface tablet, and a new version of Windows overhauled to add touch controls. Photographer: Stuart Isett/Bloomberg

Microsoft Corp. (MSFT:US), the world’s largest software maker, is proving the value of an AAA rating.

The designer of Windows operating systems with a credit grade (MSFT:US) that Standard & Poor’s deems better than the U.S. government’s sold $2.25 billion of bonds last week at tighter relative yields than a year ago, according to data compiled by Bloomberg. Spreads widened in the same period for corporate bonds globally of all types, Bank of America Merrill Lynch index data show.

The supply of top-rated corporate bonds has tumbled 64 percent as firms from General Electric Co. (GE:US) to billionaire Warren Buffett’s Berkshire Hathaway Inc. lost their AAAs after the 2008 collapse of Lehman Brothers Holdings Inc. ignited the worst financial crisis in eight decades. Redmond, Washington-based Microsoft’s balance sheet (MSFT:US) has since strengthened, with a record $67 billion (MSFT:US) of cash and short-term investments.

“Microsoft carries a certain level of cachet in this market as a highly defensive and economic resilient borrower,” said Thomas Chow, a money manager at Delaware Investments in Philadelphia with about $170 billion under management. “It’s as strong and well recognized of an issuer as one can expect.”

Tighter Spreads

The least-leveraged software maker sold $600 million of 0.875 percent, five-year notes on Nov. 2 that yielded 27 basis points more than similar-maturity Treasuries, $750 million of 2.125 percent, 10-year securities at a 47 basis-point spread and $900 million of 3.5 percent, 30-year bonds at 67 basis points, Bloomberg data show.

The new bonds paid less relative to government securities than when Microsoft issued an equal amount of similar-maturity notes on Feb. 3, 2011, even after relative corporate yields worldwide increased 19 basis points to 227 basis points, or 2.27 percentage points. That similarly sized sale included 2.5 percent, five-year notes yielding 38 basis points more than Treasuries, 4 percent, 10-year bonds at 48 basis points and 5.3 percent, 30-year securities at 68 basis points.

Six months later, S&P cut America’s credit grade to AA+. Moody’s Investors Service ranks the U.S. as Aaa.

An average coupon of 2.34 percent on Microsoft’s new bonds compares with a 3.2 percent rate that it paid on $12 billion of outstanding securities before last week’s sale, $2.25 billion of which mature next year (MSFT:US), Bloomberg data show.

‘Very Attractive’

“It’s not particularly compelling from a spread point of view, but from the point of view of increasing credit quality, it’s very attractive,” said Bonnie Baha, head of global developed credit at Los Angeles-based DoubleLine Capital LP, which oversees more than $45 billion.

All three issues rose in secondary trading today. The five- year notes gained 0.1 cent on the dollar to 99.6 cents for a yield of 0.96 percent at 11:26 a.m. in New York, the 10-year debt rose 0.6 cent to 99.86 cents to yield 2.14 percent, and the 30-year bonds rose 0.6 cent to 99.1 cents to pay 3.55 percent.

Microsoft’s debt has never exceeded (MSFT:US) its earnings before interest, taxes, depreciation and amortization. Its current leverage of 0.41 times is the least among publicly traded software firms with at least $1 billion of debt, including Oracle Corp. (ORCL:US) and SS&C Technologies Holdings Inc. (SSNC:US), which carry a median debt load of 1.68 times earnings, Bloomberg data show.

Peter Wootton, a spokesman for Microsoft, declined to comment on the company’s finances. Proceeds from the new bonds may be used to buy stock, fund acquisitions or repay existing debt, the company said last week in a regulatory filing.

Global Growth

Investors are seeking bonds of the most-creditworthy borrowers as the International Monetary Fund lowers its global growth forecast to the slowest pace since the 2009 recession.

The IMF on Oct. 9 predicted 3.3 percent growth this year and 3.6 percent in 2013, compared with July predictions of 3.5 percent for 2012 and 3.9 percent next year. The lender now sees “alarmingly high” risks of a steeper slowdown, with a one-in- six chance of growth slipping below 2 percent.

The face value of outstanding corporate debt worldwide that’s ranked AAA has plummeted to $158 billion last week from $445 billion in May 2008, according to Bank of America Merrill Lynch index data.

“There’s not enough AAA paper to go around right now,” Jody Lurie, a corporate credit analyst at Janney Montgomery Scott LLC in Philadelphia, said in a telephone interview. That helps Microsoft, which is “the type of name that institutional investors need in their portfolio,” she said.

The biggest holders (MSFT:US) of Microsoft bonds include Vanguard Group Inc., the largest U.S. mutual-fund firm, and BlackRock Inc., which manages more financial assets than any other company, data compiled by Bloomberg show.

Free Cash

Of the four non-financial U.S. companies rated AAA by S&P or Aaa by Moody’s, Microsoft is the most profitable.

Its gross margin of 74 percent leads Johnson & Johnson (JNJ:US), Exxon Mobil Corp. and Automatic Data Processing Inc. It’s 33 percent operating margin, also the highest, compares with a 22 percent average, Bloomberg data show.

That’s helped Microsoft generate more free cash (MSFT:US) than 99 percent of S&P 500 stock index members.

The company earned $29 billion of funds in its last fiscal year that it can use to reward shareholders through dividends or stock buybacks, to reinvest in the company or to pay down debt, more than any non-financial firm except Apple Inc. (AAPL:US), which doesn’t have debt and isn’t rated by Moody’s or S&P.

“Because of how stable their cash flow is, there’s generally a lot of demand,” Greg Tornga, head of fixed income at Edge Asset Management in Seattle, which manages about $22 billion and owns Microsoft debt, said in a telephone interview. “It’s a very stable investment from a bond standpoint.”

Mobile Phone

Microsoft’s bond sale comes with the personal-computer industry forecast to have its worst year since 2001 as consumers switch purchases to tablet machines like Apple’s iPad and smartphones. Microsoft is responding with the release of its first computer hardware device, the Surface tablet, and a new version of Windows overhauled to add touch controls.

The company is also making plans for a possible mobile phone of its own, according to people with knowledge of the matter who asked not to be identified.

While the company’s free cash flow at more than double its $12 billion of total debt has helped bolster the balance sheet, about 87 percent of its cash and equivalents were held overseas and subject to repatriation taxes as of Sept. 30, according to a quarterly regulatory filing.

‘Cheap Financing’

That raises the chances that Microsoft, which had about $7.2 billion remaining in its share buyback program, will use borrowed money to repurchase stock, according to Alan Shepard of Madison, Wisconsin-based Madison Investment Holdings Inc.

Under current law, American companies can defer federal income taxes on most overseas earnings indefinitely. When they do return to the U.S., they’re taxed at the corporate rate of 35 percent -- with credits for foreign income taxes paid. Companies paying little overseas face higher U.S. tax bills upon repatriation and may save money by borrowing instead.

“My feeling is that they’re using cheap financing to move funds back to the U.S., which may be used for repurchases,” Shepard, whose firm oversees about $16 billion and owns Microsoft debt, wrote in an e-mail. “It’s a shareholder- friendly move, but it should have no effect on the company’s overall credit quality.”

To contact the reporter on this story: Charles Mead in New York at cmead11@bloomberg.net

To contact the editor responsible for this story: Alan Goldstein at agoldstein5@bloomberg.net


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