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Commentary: Sign Of An Apocalypse In Private Equity?


Could Microsoft (MSFT) be bought out? That's precisely what the Financial Times of London recently called for. A consortium of private equity firms, the FT wrote, could cobble together the $288 billion needed -- nearly nine times more than the largest deal ever made. Why dare? "In truth," wrote the FT, "Microsoft would be worth more off the [public] market than on it."

The fact that anyone is talking seriously about such a colossal deal might in itself signify the high-

water mark of the private-equity boom. To consider Microsoft buyout bait is to believe that no target is too big. After all, money was no object when Bain Capital, Kohlberg Kravis Roberts, and Merrill Lynch Global Private Equity (MER), among others, recently pulled off a $33 billion deal for hospital operator HCA (HCA), eclipsing the size of the 1989 RJR Nabisco Holdings buyout. What's another quarter-trillion bucks among friends?

The idea of privatization is rooted in valid frustrations. A maturing Microsoft has been a lazy steward of its capital structure, which, with at least $34 billion in cash and not a dime of debt, is lopsided and has been for years. That was fine when the stock was soaring. But Microsoft shares have round-tripped back to the price at which they traded this time eight years ago, despite the company tripling earnings per share and, since 2004, paying dividends in excess of $39 billion. Management also failed to capitalize on an incredibly cheap debt market to bolster shareholder returns.

The go-private camp makes a fair point when it argues that buyout firms could probably trim enough fat from Mister Softee to make their enormous investment profitable. "In theory, someone could 'cash-cow' it and cut expenses to make it work," agrees L. Alan Davis, an analyst with Lake Oswego (Ore.) investment bank D.A. Davidson & Co.

But practically speaking, it's not going to happen. "Snakes on a Plane will win a best picture Oscar before Microsoft gets acquired by LBO firms," sniffed Daniel Primack, editor of PE Week Wire, a daily private-equity e-mail newsletter.

For starters, the FT plan assumes Microsoft management is ready to raise the white flag, when in fact it's still keen to invest billions more to take on rivals like Google Inc. (GOOG). Going private would mean gutting billions from research and development and paring thousands of employees just to service the new debt, starving the pipeline of new products (and by extension, squeezing future profits).

The equity portion of a Microsoft megabuyout would have to be at least $30 billion and more like $50 billion or $80 billion. It would be a stretch for 15 shops even to come up with, say, $4 billion apiece (a prohibitively large chunk of even the leading buyout funds), much less join together in harmony. And even if they somehow scared up $80 billion, $200 billion or so in debt would still have to be financed on daredevil terms. "In software," says A.G. Edwards & Sons Inc. analyst Yun Kim, "that kind of leverage just isn't done."

There is, of course, another way -- one that also has the benefit of being rooted in reality: privatization lite. Microsoft could devote much more of its free cash to share buybacks and fatter dividends (which the LBO guys would surely pay themselves anyway). Investors seem to like this notion. Most refused to cash in their shares at the high end of Microsoft's recent tender offer, holding out for a higher price. The stock has gained 20% since June. Microsoft upped the ante by jacking up its buyback plan by more than $16 billion, to $36.2 billion.

Not enough juice? Then it could take out a slug of debt to absorb even more of its shares outstanding. It's conceivable that Microsoft could safely reabsorb a quarter of its share count, all told. Reclaim those stock certificates, and each remaining holder has a fatter claim on earnings that stand to pick up over time. While that solution might not be a $288 billion LBO-zilla, it's the kind of results-oriented deal that the Brits might hoist a pint to.

By Roben Farzad


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