Corporate Repurchase and Buyback of Microsoft - Research Paper Example

Running Head: Corporate Repurchase Why do Corporations Repurchase their Own Stock and Discuss Microsoft's Use of the Practice in both their 2006 and 2008 Buyback Plans [Writer's Name] [Institute's Name] Abstract In this paper we have discussed what a 'corporate repurchase' or 'corporate buyback plan' is. We have also identified different situations in which corporations repurchase their own stocks and the reasons for doing so. When a company limits the number of its outstanding shares available for the public, it's earning per share (EPS) ratio increases, which is an indicator of the business' profitability. Microsoft's Buyback Plans for the years 2006 and 2008 have been discussed in great detail. The different situations and reasons for the implementation of these two plans have also been identified. Why do Corporations Repurchase their Own Stock and Discuss Microsoft's Use of the Practice in both their 2006 and 2008 Buyback Plans Corporations fund their businesses by issuing stocks that are purchased by the investors. This is an indication of a growing business when people are buying business' stocks. The business growth benefits both, the owners, as well as the investors. In order to extend the stock fundraising, corporations repurchase their stocks. This process is commonly known as a 'corporate repurchase'. 'Repos', 'buybacks', 'reverse repos', 'or 'repurchase agreements' are also some terms implying the same process. (WiseGEEk, 2009) A repurchase agreement, also known as lending buyback occurs when all or some of the securities, comprising of bonds, stocks, or money markets; are sold by the corporation at a premium. The corporation agrees to buyback these securities later at a higher price. A repurchase agreement is very similar to a 'secured loan' in different ways as the securities are taken as collateral. Typically, the repayment takes place after a few months. This is the case of a short option loan. Long option loan, for which repayment can be prolonged up to two years, are not so common. (WiseGEEk, 2009) When corporations buy their own stocks from the general market or stockholders in a systematic fashion, it is called a corporate buyback. In order to cut down the costs of the repurchase agreement, the corporations can combine it with a corporate repurchase program. This is a possibility when there are two differing ideas. (WiseGEEk, 2009) A corporate repurchase program can strategically explain that a company thinks of its stock in the market as undervalued. When the companies offer a buyback plan, they are actually cutting down the amount of outstanding stocks, as corporate heads are allowed to buy stocks from stockholders. Thus, the stock price goes up. (WiseGEEk, 2009) A corporate repurchase may also be undertaken for other reasons. It can be used to offset the costs that are incurred when companies offer a compensation package to the workers. It may also be used to strengthen internal control. A company's stock earnings weaken when it is offering stock options or provides for a 401K. Stocks are brought back into the control of the company when a buyback occurs. The worth of stocks also increases for the existing stockholders. (WiseGEEk, 2009) A corporate repurchase can be carried out in several ways. For instance, existing stockholders can be consulted. An offer is made to them to purchase the stocks at a premium. Investors do not get much time to accomplish it. Another way of repurchasing stocks is by acquiring stocks on the market. This process takes a long time. Corporate repurchase is indeed a very effective way that enables businesses to purchase the company back from stockholders. If 100% of the company's stocks are bought back, the corporation may become private and abandon the public trade method. (WiseGEEk, 2009) Buybacks are a way of administrating the buyers' market. The process limits the stocks for investors. Supply and demand of stocks is controlled when a company engages in a buyback. A buyers' market is transformed into a seller's market as the number of stocks available for acquisition becomes limited. (WiseGEEK, 2009) Buybacks don't just affect the buyer's market, but also influence the corporation itself. Idle cash reserves can be put to use and the corporation may benefit from raised earnings per share ratio. At times the recovered stock is used for employee pension plans or employee stock ownership plans. (WiseGEEK, 2009) Buybacks may fail to achieve the desired outcome if they are not able to influence the buyer's market. If interest in the buyer's market is not generated with the limited number of shares available for acquisition, EPS is not going to rise to an appreciable level. In such a case, the cash reserves go to waste as they could have been put to a revenue generating use. Henceforth, corporate repurchases are desirable when share recovery can make perspective investors' demand for remaining shares increase. When such a scenario is not present, corporations should delay the repurchase plan and implement only when the buyer's market has the potential to respond positively. (WiseGEEK, 2009) Microsoft, the software maker, has been practicing and benefiting from it's corporate repurchase plans in the last decade. In 2006 Microsoft's profits had gone down by 24% due to legal expenses and high costs. It came as a surprise when Microsoft issued the forecasted profits for the year 2007. Microsoft had planned to buyback $40 billion worth of its stocks. As a result share supply had increased sharply in the after hours. (Amanda Cantrell, 2006) In July 2006, Microsoft had announced its net income to be $2.83 billion. This meant 28 cents per share and was inclusive of a 3 cent fine charged by the European Union (EU). This was only a penny more than the Wall Street's forecast. $11.8 billion of sales were reported while analysts had predicted it to be $11.6 billion. The reported sales were 16% more than the year-ago quarter. At that time Microsoft released its repurchase plan of $20 billion to be carried out by August 17, 2006. It further announced the authorization of purchasing over $20 billion worth of shares by June 2011.Mr. Toan Tran, equity strategist Morningstar, had commented that it was a very intelligent step to boost the stock value. 6% gain in stocks was reported in after-hours trading. (Amanda Cantrell, 2006) Analysts and investors were frustrated when Microsoft announced its forecasted operating income to be $2 billion less than the analysts' estimate for the next fiscal year. The launch of Windows Vista operating system was also delayed and further disappointed the analysts and investors. Mr. Chris Liddell, Microsoft's chief financial officer at the time, had clarified the issues relating to higher spending to stifle the frustrated analysts. He explained that Microsoft expected to make losses on the shipments of Xbox 360 gaming consoles. There were also expenses relating to Windows Vista launch and other new investments. (Amanda Cantrell, 2006) $450 million were to be spent on the expansion of Microsoft's marketing team and the sales force. Another $450 million were to be spent on the marketing of Windows Vista. Mr. Liddell had also announced that the corporate customer version of Windows Vista was t be launched in November, while customer version was to be launched in January 2007. $1 billion were to be spent on the high-growth areas like servers, business intelligence, and other areas which were to be announced later. (Amanda Cantrell, 2006) Mr. Liddell declared that Microsoft intended to invest $500 million to bolster the retooling of its MSN division, which was still struggling, while Yahoo! and Google were fairly settled. It was also announced that $300 million were to be spent on potential acquisitions and to cover other higher expenses. (Amanda Cantrell, 2006) According to Mr. Tran of Morningstar, Microsoft's shares boosted after Microsoft released its earnings and sales guidance for the next fiscal year, which were better than the analysts' predictions. Microsoft had declared its earning per share to fall in the range of $1.43 to $1.47 for that fiscal year. This was higher than Microsoft's former expectation of $1.36 to $1.41 and also analysts' forecast of $1.40. (Amanda Cantrell, 2006) Mr. Tran, Morningstar analyst, also pointed out another reason for hanging on to Microsoft's stocks, the long-awaited launch of Windows Vista and other new products. Microsoft had announced in July 2006 that it was going to launch its music software and hardware as a competitor of Apple's iPod and iTunes. The company was also anticipated to have made huge shipments of its video-game, Xbox 360 consoles, despite the fact that Sony's PlayStation 3 was a strong existing competitor in the market. Microsoft's new server business is also a promising area. (Marc Hogan, 2006) The share buyback plan was to help Microsoft in lowering the number of its outstanding shares and thus improve Microsoft's earnings per share. An analyst, Rick Sherlund, had pointed that stocks of the company were to benefit because of its buyback plan, its earnings and sales guidance for the coming year, and also because the company produced better results than the analysts had expected it to. (Amanda Cantrell, 2006) Mr. Liddell, commenting on Microsoft's buyback plans, said that it was a way of reaffirming the long-term trust and optimism as Microsoft believed in sticking to its strategy of giving capital returns to its stockholders. Mr. Liddell also announced the successful completion of the company's repurchase plan worth $30 billion which was announced in 2004. (Ina Fried, 2006) Microsoft used the modified Butch auction method to carry out its tender offer. Shareholders who were willing to sell their shares were able to indicate the number of shares they were willing to sell. They were also able to indicate the price at which shareholders wanted to sell these shares at. Microsoft had declared that it would not pay less than $22.50 per share and not more than $24.75 per share. After this announcement, it was forecasted that Microsoft would buyback up to 808 million shares which formed approximately 8.1% of its all outstanding shares. (Ina Fried, 2006) In September last year, amid chaotic money market, Microsoft announced the launch of its $40 billion repurchase plan which was to expire in September 2013. It also announced that it would increase the dividend and take debt. On 30th June, 2008, Microsoft's short-term investments and cash on hand amounted to $23.7 billion. Microsoft's past record indicates that it has always refrained from taking debts for stock buybacks, and day -o-day acquisitions or operations. (The Boston Globe, 2008 and Microsoft, 2008) While credit problems afflicted the financial markets, investors became reluctant to take high risks. Big league companies such as Microsoft found interest rate to be lingering at 2% on the commercial paper. Microsoft then decided that it will borrow. Microsoft's board accepted a $2 billion commercial paper program which was a part of its open-ended allowance for debt financing worth $6 billion. Microsoft was accredited to have the highest debt ranking by the Standard & Poor's Rating Services and the Moody's Investors Service. (The Boston Globe, 2008) The quarterly dividend was increased from 11 cents to 13 cents for the shareholders on record as of November 20th and was payable on December 11th. This raise in the dividends, along with Microsoft's debt offering and the buyback plan, bolstered Microsoft's shares which increased by 24 cents, closing at $25.40 as of September 22, 2008. (The Boston Globe, 2008) The buyback plan was going to enable Microsoft to limit the number of shares for the public. This was in turn going to make Microsoft's shares more attractive for the investors as Microsoft's earnings per share (EPS) ratio was going to rise. The cash that would have otherwise been used for investing in marketing, new products, and innovation, was used for the financing of the buyback plan. However, this usually leads to increased stock prices, giving benefit to the Microsoft employees, shareholders, and its executives. (Michael M. Grynbaum, 2008) According to Mr. Bruce Bittles, the chief investment strategist at Robert W. Baird & Company, companies repurchase their shares if they see new prospects and think of their stocks as accessibly cheap. However, he says that companies' intentions are not always obvious. They may just buy their stock back if they can't put their money to any other use. They would rather buyback their own stocks instead of investing in Treasury bills and earning nothing. Mr. Bittles was pointing the notes issued by the US government that yielded practically nothing. (Michael M. Grynbaum, 2008) Microsoft's repurchase plan had bolstered the stock market as investors saw some hope in the technology sector. Microsoft had also been able to complete its former $40 billion buyback plan which was a positive sign for the investors. The company has been able to return more than $115 billion in the five year period before that to its customers. This amount included the dividends and the share buybacks. (Michael M. Grynbaum, 2008 and Microsoft, 2008) References WiseGEEK, What is a Corporate Repurchase, 2009, http://www.wisegeek.com/what-is-a-corporate-repurchase.htm, Accessed on 29th July, 2009 WiseGEEK, What are Buybacks, 2009, < http://www.wisegeek.com/what-are-buybacks.htm>, Accessed on 29th July, 2009 WiseGEEK, What is a Repurchase Agreement, 2009, < http://www.wisegeek.com/what-is-a-repurchase-agreement.htm>, Accessed on 29th July, 2009 Amanda Cantrell, CNN Money, Microsoft jumps on buyback plan, July 20, 2006, < http://money.cnn.com/2006/07/20/technology/microsoft_earnings/index.htm>, Accessed on 29th July, 2009 Ina Fried, ZDNet News, July 20, 2006, http://news.zdnet.com/2100-9595_22-148899.html, Accessed on 29th July, 2009 Michael M. Grynbaum, Microsoft, Hewlett Packard and Nike Announce Buyback Plans for Shares, The New York Times, September 22, 2008, http://www.nytimes.com/2008/09/23/business/23buyback.html, Accessed on 29th July, 2009 The Boston Globe, Microsoft's buyback plan shows strength of tech firms, September 23, 2008, http://www.boston.com/business/markets/articles/2008/09/23/microsofts_buyback_plan_shows_strength_of_tech_firms/, Accessed on 29th July, 2009 Microsoft, Microsoft Announces Share Repurchase Program and Increases Quarterly Dividend, September 22, 2008, http://www.microsoft.com/presspass/press/2008/sep08/09-22dividend.mspx, Accessed on 29th July, 2009 Investopedia, Earnings Per Share, 2009, < http://www.investopedia.com/terms/e/eps.asp>, Accessed on 30th July, 2009 Marc Hogan, Microsoft Buyback: Should You Bite, July 21, 2006, http://www.businessweek.com/bwdaily/dnflash/content/jul2006/db20060724_115939.htm, Accessed on 30th July, 2009 Read More