July 22, 2008 / 8:25 PM / 11 years ago

Microsoft should issue debt for a buyback--analyst

SEATTLE, July 22 (Reuters) - Microsoft Corp (MSFT.O) should take on debt to repurchase stock as a way to revive its flagging share price, a financial analyst said in a new report issued on Tuesday.

Friedman, Billings, Ramsey & Co analyst David Hilal called on the company to take advantage of its predictable cash flow and rock solid balance sheet to execute a leveraged buyback.

Hilal argues that by taking on debt to repurchase shares, Microsoft will have the flexibility to put in place a large share buyback without compromising the ability to be acquisitive.

“The financial impact of a leveraged buyback should improve Microsoft’s valuation and affirm management’s faith in the company’s prospects and change the perception that management does not care about its stock price,” wrote Hilal in a note to clients.

Microsoft’s stock has fallen 28 percent in 2008. The shares are trading at 12 times estimated fiscal 2009 earnings compared with a price-to-earnings ratio of 20 for the software sector. The stock closed up 16 cents at $25.80 in Nasdaq trading on Tuesday.

Last week, Chris Liddell, Microsoft’s chief financial officer, said the company was “disappointed” its strong financial results were not reflected in its share price. The normally reserved CFO said a buyback was “incredibly attractive” at these price levels.

The comments were a departure from the company’s standard line that, if Microsoft takes care of earnings, the share price will take care of itself.

The company will address Wall Street analysts on Thursday at its annual financial analysts’ meeting at its Redmond, Washington headquarters.

Microsoft has been aggressive in buying back shares. It has $3 billion left to spend as part of a $36.2 billion five-year share repurchase program it started in 2006.

The company has said it will go back to its board of directors once the current amount has been spent to decide on a next share repurchase program.

“Given the pace of its share buybacks, we expect Microsoft to exhaust its current repurchase program in the current quarter,” Hilal wrote in the note entitled, “Come on Steve, How About a Leveraged Buyback?”

Hilal, referring to Microsoft Chief Executive Steve Ballmer, rates the stock an “Outperform” with a $40 price target.

The company has never issued debt in its history, but Liddell said in February it would likely to do so if its pursuit of Yahoo Inc YHOO.O was successful. A deal between the two companies has not panned out.

While it has not raised the possibility of debt issuance in recent months, analysts note Microsoft’s strong balance sheet would allow the company to get debt at a low price.

According to Hilal’s research, a $20 billion leveraged buyback would boost its calendar 2009 earnings per share by 7 cents. A $35 billion repurchase would add 13 cents and a $50 billion buyback would be accretive by 20 cents.

The company, whose fiscal year does not follow the calendar year, has forecast earnings per share in a range of $2.12 to $2.18 in its fiscal year ending in June 2009. It does not offer a forecast for the calendar year.

Microsoft generates about $5 billion a quarter in cash from operations and it had about $23.6 billion in cash and cash equivalents at the end of June.

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