Microsoft (NASDAQ: MSFT) just showed investors the money, in a big way. Microsoft approved a whopping $40 billion share repurchase program. In addition to the Microsoft buyback, it also raised its dividend by 8%.
In the tech sector, it is common for stocks to either pay dividends to shareholders or buy back lots of their own stock. But it is much rarer to find a company that does both.
Microsoft is the rare example of a company that generates so much cash it can repurchase billions of dollars of its own shares and raise its dividend at high rates each year. The company also has a AAA credit rating, according to Standard & Poor’s. It’s one of only two publicly-held U.S. companies to hold the distinction.
Here’s how Microsoft has turned itself into a cash machine.
A True Cash Cow
Microsoft built its business on its Windows operating system and Office software suite. With these products, it enjoys a dominant market share in the personal computer business. Since Microsoft does not have to spend much on manufacturing or distribution costs, it generates extremely high profit margins and huge amounts of free cash flow.
Consider that in fiscal 2016, Microsoft generated $25 billion of free cash flow, up 5% from the previous fiscal year. In addition, revenue clocked in at $92 billion for the fiscal year. That means Microsoft’s free cash flow represented approximately 27% of its annual revenue, a remarkable level of free cash flow generation that speaks to the strength of its business model.
With relatively modest annual capital expenditure needs, all that cash flow has amounted to an enormous cash hoard on the balance sheet. Microsoft ended last quarter with more than $110 billion in combined cash, cash equivalents, and investments.
Meanwhile, Microsoft has about $62 billion in total long-term liabilities. To put that into perspective, that means Microsoft could theoretically pay off all of its long-term debt with its cash and investments on hand, and still have more than $50 billion left over.
Since interest rates remain near historic lows, all that cash is earning virtually nothing for Microsoft and its shareholders. That money is burning a hole in the company’s pockets; hence the Microsoft buyback and why it has started to put that cash to work recently.
For example, in June Microsoft announced it will acquire LinkedIn (NASDAQ: LNKD) for $26 billion, to further its position in professional software and services, particularly when it comes to the enterprise. The other key strategy for Microsoft is to expand its cloud-based businesses.
Microsoft’s Head in the Clouds
While Microsoft’s dominance in PCs helped it become the industry juggernaut it is today, it is also true that the PC is in trouble. As more consumers utilize smartphones and tablets for computing, the PC is being left behind. For instance, technology market research company Gartner (NYSE: IT) found that global PC shipments fell 5% last quarter. That marked the seventh in a row of sales declines.
Furthermore, Gartner expects PC sales to fall 1% in 2016, which would be the fifth consecutive year of declines.
That is why Microsoft has engineered a major turnaround, based on the cloud. This strategy has worked wonders thanks to Microsoft’s flagship cloud services Office 365 and Azure. Last quarter alone, revenue from Office 365 jumped 59% while Azure revenue more than doubled year over year.
This growth is supplemented by Microsoft’s other products, including tablets and gaming devices. The Surface Pro 4 and Surface Book drove 9% revenue growth from tablets last quarter. The Xbox One gaming console drove more than 30% growth in Xbox Live subscriptions last quarter. Going forward, the company has announced a new iteration of the Xbox, called the Xbox One S, which should fuel growth in 2017.
Microsoft Buyback and Earnings Growth
Microsoft is growing once again due to its focus on cloud services and new hardware products. Its huge $40 billion share repurchase will help drive future earnings growth, and the stock pays investors a solid 2.6% dividend.
As a result, Microsoft is an attractive stock pick for investors looking for growth, income or a combination of both.