Why Microsoft Is Tapping The U.S. Debt Market?

Microsoft (NASDAQ:MSFT) is tapping into the debt markets, issuing a total of  $10.8 billion in various tranches with different amounts and maturities. ((Microsoft SEC Filing)) This offering will allow Microsoft to take advantage of low funding cost as Fed continues to keep interest rate at record low levels. Microsoft sold notes and bonds in six issuances, including $2.25 billion of 40-year obligations with a 4% coupon, according to data in company’s sec filings. The 40 year bonds sold at a yield of 153 basis points more than 30-year Treasuries. Microsoft has a massive cash balance – standing at $90 billion as of the last quarter and its free cash flows remain strong. However, the move to issue debt underscores the problem that most of the companies are facing from secular stagnation and inability to generate returns in excess of options available to the investor.  Microsoft plans to use the proceeds from the offering for general corporate purposes, which may include capital expenditures, stock repurchases, acquisitions and debt repayments, according to a regulatory filing with the U.S. Securities and Exchange Commission (SEC). This move to raise cash through debt makes a lot of sense for Microsoft given the low interest rate environment in the U.S. and the company’s need to fund its operations without repatriating its overseas cash, which accounts for 91% of the cash and cash equivalent at the end of fourth quarter.

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Taking On Debt Is More Tax-Efficient For Microsoft

Microsoft has strong credit rating of AAA founded on its strong position in the software industry. As a result, it has the ability to raise debt at lower interest rates compared to some other companies. Therefore, demand for Microsoft’s debt offering is very strong considering the low interest environment in the U.S. This bond issue is bigger in comparison to the company’s previous issues in the U.S. market, when it when it sold $8 billion of securities in dollars and euros.

Microsoft has been in the middle of its shareholder returns program and has been steadily bolstering its share repurchases and dividends. The company had authorized a $40 billion share buyback program in September 2013, and had repurchased about $9 billion worth of shares as of December 2014. Microsoft also raised its quarterly dividend by about 11% in 2014 to $0.31 per share. This has meant that the company’s total capital return program has increased to about $50 billion. Considering that that 91% of its current cash reserves are located overseas, and the company would face repatriation taxes if it were to bring the funds back to the United States, which would be very tax-inefficient. Therefore, it seems that the company may need more cash to fund the program. As a result, Microsoft has been steadily increasing its debt load to fund its shareholder returns.

Raising Debt Makes Sense From The Cash Flow Perspective

Raising debt to repurchase shares is also attractive from a cash flow perspective, since the company’s borrowing costs for the next ten years are lower than its trailing dividend yield, which stands at over 2.9%. While the 5 years notes due in 2020 have an interest rate of 1.85%, the bonds due in 2025 have an interest rate of 2.7%. These bonds account for $5.25 billion or nearly 50% of the total debt offering. We believe that these bonds will be used for share repurchases. However, we expect that the 20, 30 and 40 years bonds will be used for financing corporate expenses, and help the company to lower its cost of operations, especially over the coming years as Fed looks to raise interest rates that will make subsequent debt costlier. Additionally, since interest payments are tax deductible, the company will be able to potentially lower its tax burden.

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