The above chart shows Microsoft’s annual dividend per share, excluding special dividends, from fiscal year 2003 through the current annualized dividend rate of fiscal 2017. Percentage increases for each fiscal year are on display as well. Dividends are classified in the fiscal year in which they were announced.
By Kris Rosemann
We have a few things to say about Microsoft (MSFT). Let’s begin this recap of some recent news with an excerpt from our most recent piece on the company, “Microsoft With Its Head in the Clouds? (July 2016)”:
We’re doing well in both newsletter portfolios in part because we’re not taking on foolish risks in an overheated market, and we continue to feel that a reduction to the weighting in Microsoft in the Dividend Growth Newsletter portfolio several weeks ago was a prudent move, especially given our opinion of the LinkedIn deal and Microsoft’s full valuation (it’s still fairly valued, in our view). You’ll note that the beauty of the move is that we still retain exposure to Microsoft, which as fiscal fourth-quarter results revealed, remains attractive and is showing positive momentum in terms of adoption rates of its cloud-based services. We continue to hold Microsoft as we watch its story unfold with high hopes for its redefined business model. And yes, we’re still nervous about a meaningful impairment charge related to the LinkedIn acquisition down the road, but that may not mean much now. Most experienced investors are already writing it off…we are.
Microsoft delivers again.
Though Microsoft continues to deliver excellent quarterly performance, our expectations for superb long-term dividend growth remain tempered to a degree as a result of the $26+ billion purchase of LinkedIn (LNKD), a move we have been critical of from the beginning, “What?!?! Microsoft Acquires LinkedIn; NO! (June 2016).” The $26 billion Microsoft will pay for LinkedIn could have gone a long way in future dividend increases, and the professional networking website has nowhere near the free cash flow generating capacity as the remainder of Microsoft’s business. From our June 2016 note:
Microsoft will finance the transaction primarily through the issuance of new debt as it seeks to complete its $40 billion buyback program by the end of 2016, but income investors have been left in the cold with this transaction; it raises a big question about the board’s long-term commitment to the pace of dividend growth, even if future increases are assured. We want big increases to Microsoft’s dividend, not marginal ones. The numbers are terrible: LinkedIn’s near-$3 billion revenue stream in 2015 is but a fraction of Microsoft’s $90+ billion mark, and the professional networking entity’s negligible net income is sad: -$166.1 million (negative, 2015), -$15.3 million (negative, 2014), $26.8 million (2013), $21.6 million (2012), and $11.9 million (2011). By comparison, Microsoft generated, on average, $19 billion in net income during the past three years. Free cash flow at LinkedIn averaged ~$160 million during the past three years (2013-2015), while this mark has been nearly $25 billion on average at Microsoft during its past three fiscal years (2013-2015).
On September 20, Microsoft announced an 8% increase in its quarterly dividend and authorized an additional $40 billion in share repurchases, the latter of which has no set time horizon to be completed and can be terminated at any time. The 8% increase is the firm’s smallest step change in terms of a percentage increase in its dividend paying history, but the absolute magnitude of the increase is in-line with several prior dividend hikes. Since the addition of shares to the Dividend Growth Newsletter portfolio in late 2011, the company has increased its quarterly dividend each fall by 15% (calendar 2012), 22% (2013), 11% (2014), and 16% (2015). Not bad — actually, it’s quite good.
On the basis of the software giant’s valuation, we’re not particularly fond of Microsoft’s decision to add $40 billion to its share repurchase program as it remains on track to complete its current $40 billion authorization by the end of 2016. Microsoft’s shares are currently trading in the upper half of our fair value range, indicating that we feel buybacks are not adding economic value at this point in time. Though there could be a much better use of the $40 billion in cash, in our opinion (as in the form of a dividend hike), the flexibility embedded in the share repurchase program should keep management from destroying value if it opts to gobble up shares should or if they become undervalued again.
All things considered, nothing material has changed with respect to our opinion of Microsoft. The LinkedIn deal will inevitably impact Microsoft’s balance sheet, but as of the end of fiscal 2016, the firm had a net cash position of just under $60 billion. Even after the addition of ~$26 billion in debt, its net cash position will be far greater than many of its dividend paying “peers.” In this light, we continue to view Microsoft as one of the more attractive dividend payers on the market. Its dividend is fully funded by internal cash flow–unlike MLPs and REITs who are dependent on capital markets to maintain a competitive and growing dividend–and shares remain fairly valued unlike many high-PE consumer staples entities with similar payout yields and dividend growth histories.
Shares are up more than 120% since their addition in December 2011 as of the close September 21 and currently yield ~2.5%. Yes, we still like Microsoft.