6 Min Read
Dec 19 - Fitch Ratings has affirmed Microsoft Corp.'s (Microsoft) ratings as follows: --Long-Term Issuer Default Rating (IDR) at 'AA+'; --Senior unsecured debt at 'AA+'; --Short-Term IDR at 'F1+'; --Commercial paper (CP) program at 'F1+'. The Rating Outlook is Stable. Approximately $14 billion of debt is affected by Fitch's action, including Microsoft's issuance of $2.25 billion of senior notes on Nov. 7, 2012. Microsoft's ratings and Outlook reflect the following: --Fitch anticipates mid-single-digit revenue growth in fiscal year 2013 ending June 30, primarily supported by several new major software product introductions, including Windows 8, Windows Server 2012 and Office 2013, which is expected to be released near the end of calendar year 2012. Consumer demand for Windows 8 will also be facilitated by the greater availability and broader selection of touch-enabled PCs in a variety of form factors from original equipment manufacturers. Continued macroeconomic challenges led by Europe and enterprise delays in adopting new PC operating systems will temper near-term growth of Windows 8. --Surface will contribute minimally to free cash flow (FCF) in 2013, given the initial lack of scale and highly competitive landscape for tablets. Microsoft's Surface Pro tablet, expected in early calendar 2013, is likely to be a commercial success given its compatibility with Microsoft Office applications, enhanced security and easier manageability. Critical success factors for Surface Pro will be battery life, cost and availability of key apps. --Fitch believes Microsoft has strengthened its position in the mobile phone market in the past year as a result of licensing agreements with the vast majority of Android device manufacturers and the launch of Windows phone 8 in late October 2012. --The company's Online and Entertainment & Devices segments (Bing, Xbox, Skype, Windows Phone, etc.) will continue to be a drag on profitability over the intermediate term. These segments remain a critical component of Microsoft's longer-term strategy in the consumer market; however, competition remains fierce and Fitch does not expect these segments to contribute materially to FCF for the foreseeable future. --Fitch expects Microsoft to continue to produce strong FCF, in excess of $15 billion per year, which the company uses to fund its share repurchase and dividend programs. Fitch expects cash generation from operations to be strong enough to pay for modest annual increases in both dividends and share repurchases over the next several years excluding potential for meaningful acquisitions. Fitch expects all repurchases will be done within the context of FCF. --The company's sizable liquidity and superior credit profile provide a significant degree of financial flexibility within the current ratings. Going forward, Fitch believes Microsoft will become more active with acquisitions and share buybacks over time but continue to maintain a significant net cash position. --Absent broader corporate tax reform, Fitch does not expect any negative outcome from Microsoft's recent tax hearings with the Senate Permanent Subcommittee on Investigations. Credit Strengths: --Leading market positioning in its core software businesses, including over 90% in PC operating systems (OS) and 75% in servers. --Very strong balance sheet with $66 billion in cash and short-term investments. Microsoft generates nearly $1 billion in pretax income from interest and dividends alone. --Diversification of end market with consumers and enterprise demand as well as strong geographic diversification. No customer is larger than 10% of revenue. Credit Concerns: --Reliance on Windows and Office for the vast majority of FCF. In aggregate, these products accounted for nearly 80% of total operating income, excluding unallocated corporate level expenses. However, strong growth and margin expansion in the Server and Tools business has reduced the contribution of Windows and Office from a four-year high of nearly 89%. --Growing popularity of other operating systems outside of the core PC space, principally Apple's iOS as well as Google's Android and Chrome platforms. Fitch believes both platforms will continue to grow as competitive threats to Windows. --Extension of PC replacement cycle due to the popularity of tablets and smartphones. --Minimal historical success in developing profitable consumer businesses outside of Microsoft's core Windows and Office ecosystem despite significant investment over a decade-plus in other consumer markets. Fitch believes this is indicative of the challenging competitive environment. --Significant dividend and share repurchase programs, though funded entirely today by FCF, could pressure the company to issue increasing amounts of debt to avoid repatriation of foreign earnings, which represent the majority of total annual FCF. WHAT COULD TRIGGER A RATING ACTION Negative: Future developments that may, individually or collectively, lead to negative rating action include: --Penetration of alternative operating system's such as Chrome OS in the PC market and/or greater market share gains by Apple; --Greater than expected extensions of PC replacement cycles because of tablets, without a commensurate gain from Microsoft Surface. Fitch currently expects PC replacement cycles to extend on average up to 12 months. --Greater acceptance of cheaper software applications that compete with Microsoft Office such as Google Docs. Positive: Upside movement on the ratings is unlikely.