In July 2006, Microsoft announced its plan to purchase (or buy back) $40 billion worth of its stock. Two years later, in September 2008, Microsoft Corp. yet again announced another buyback program to repurchase their stock amounting to another $40 billion. (Suder, 2009) However, before we delve into Microsoft Corp.’s stock repurchasing strategies let us first understand what buyback or stock repurchasing means.
Buyback simply means the action of repurchasing something that one sold previously. In this context, something refers to stock, i.e., repurchasing the stock by the corporate enterprise that once issued it. During a share repurchase transaction, the corporate house distributes cash to the shareholders in exchange for a fraction of the outstanding shares. These shares may be kept for reissue by the company. (Stern & Chew, 2003) These stocks are known as treasury shares (or stocks), which are governed limited rights, i.e.
- They do not pay dividends.
- They do not have any pre-emptive voting rights that a shareholder has.
- The majority proportion of the total capitalization cannot be exceeded by the total treasury stock. (Berk, 2007)
A corporate buyback can be considered as a measure to buy out its outstanding shares and in turn, increase the stocks’ value in the market. Thus, a buyback is a strategy, where the corporate house can exercise control over the stocks, reduce the outstanding stocks and increase the stocks’ worth to remaining stockholders. This can be illustrated with an example. Let us assume, in an efficient market, if a company’s shares are priced at $50/share, and the company decides to buy back 100 shares for $5000, then the company has $5000 less cash but there are 100 outstanding shares. In such a scenario, earnings per share are improved as the number of outstanding shares is reduced. (Nottage, 2009)
Companies generating profits have two major implementations of the profits. One is to pay some part of the profits to the shareholders in the form of dividends and secondly, the remaining profit is retained for further use in the future of the company for reinvestment. The stock repurchase is done with some part of the retained portion of the profits. Thus, when the shares of the company are undervalued, the stock repurchases can increase their value and hence, add to the profits.
Share buybacks are also a strategy undertaken to prevent a takeover. Excessive cash generation and limited needs accumulate on the company’s balance sheet, making it vulnerable to take over as the attractive balance sheet could be utilized to pay off the debts. However, by the share buyback mechanism, the cash flow is kept lean and the high share prices make the takeover expensive. Hence, share repurchase is a part of the anti-takeover policy. (Vishwanath, 2007) There are certain companies in which the Executive Compensations are met with executive buybacks. The share buybacks are undertaken by the executives to meet the earnings per share target. (Asaf, 2004)
Share buybacks also allow the corporate house to distribute their profits to the shareholders without extra taxation. That is, if the company was to pay a 10c dividend per share to its shareholders, the taxes would be implied to the investors resulting in the investors receiving 8.5c per share. An investor with 10 shares will receive 85 c. However, during the buyback mechanism, the outstanding shares are bought up by the company and hence, there is a rise in the cost of the shares.
The dividend received by the shareholders will then be the net capital without its taxation and hence, the share repurchasing mechanism is instrumental in incurring the taxation and making sure that there is no change in the investor’s wealth. The buyback mechanism also minimizes the transaction costs. (Asaf, 2004)
Now coming back to Microsoft, in 2006, the company’s business saw lots of ups and downs. It faced legal charges that saw its earnings reduce by 3 cents per share. It also saw Microsoft Corp. lose out its profits spent in setting up new business. Its’ employee staff was also increased to boost the development of Windows and its online service MSN and Windows Live. Almost $197 million was spent on research and development for the Live service. Microsoft’s workforce increased 13 percent in the development. (Grosse, 2008)
On the other hand, Microsoft also had releases of Microsoft Office 2007 and Microsoft Vista lined up for release each with its own set of execution risks. The development of both these products cost the company almost $10.9 billion. Both the launch and marketing of this product cost was estimated to be around $450 million. Another $450 million was estimated for the growth of the sales force and marketing, and $1 billion for developments of newer products and services. Microsoft’s costs for AdCenter ad servicing tool, its search engine, Office Live and Live.com was another $500 million. (MacCormack, 2009)
With such huge expected expenditures, Microsoft strategizes the share buyback plans to bail out its outstanding stocks and increase the shares prices. According to Chris Liddell, the chief financial officer of Microsoft, the stock buyback programs were undertaken to share its confidence with its shareholders by returning capital to them. (Asaf, 2004) For its buyback programs, Microsoft used the modified Dutch auction, by which the shareholders can sell how many ever shares they want to sell at their own prices between the prices of $22.50 and $24.75 per share. (Klein, 2009) This buyback plan saw Microsoft collecting almost 8.1 percent off all the outstanding shares.
Again in the month of September 2008, it was declared that the software company had plans to repurchase their shares. Microsoft had paid over $115 billion to its stakeholders in the past five years through share repurchases and dividends. (Suder, 2008) And its further share repurchase plan was to promote the optimism and commitment it shares with its shareholders by returning capital to them. Microsoft corp. in the last fiscal year had accumulated debt financing of $6 billion with a $2 billion commercial paper program. (Klein, 2009) Microsoft intended to use the debt financing for the stock repurchase program to increase the prices of the outstanding shares and also pay off its shareholders well.
Thus, Microsoft Corp. can be said to regularly implement the buyback mechanism to regulate its stock prices and balance out its equation with its shareholders, and also supplement its plans for future investments. The buyback mechanism is being successfully implemented to stabilize the relationship between the shareholders and the corporate house of Microsoft to a great extent.
References
Asaf, S. (2004). Executive corporate finance: the business of enhancing shareholder value. London: Financial Times/Prentice Hall.
Berk, B. J. (2007). Corporate finance. London: Pearson Addison Wesley.
Grosse, D. (2008). Microsoft implements readiness as a strategic force. Global Business and Organizational Excellence, 27(5), 41-48.
Klein, D. (2009). Emerging technologies and corporate culture at Microsoft: a methodological note. Behavioral Sciences & the Law, 23(1), 65-96.
MacCormack, A. (2009). Management of Technological Transitions: Evidence from Microsoft Corporation. Journal of Product Innovation Management, (26)3, 248-263.
Nottage, L. (2009). Corporate Governance in the 21st Century: Japan.s Gradual Transformation. New York: Edward Elgar Publishing.
Stern, J. M., & Chew, D. (2003). The Revolution in Corporate Finance. New York: Blackwell.
Suder, G.S. (2008). Interview with Jean-Philippe Courtois, CEO, Microsoft EMEA. Thunderbird International Business Review, 47(2), 153-161.
Suder, G. (2009). Microsoft: A case in cross-company transformation. Thunderbird International Business Review, 48(4), 555-596.
Vishwanath, S. (2007). Corporate Finance: Theory and Practice. New Delhi: Response Books.