Thread ---This explains a lot about MSFT cash flow : very good article : Microsoft Corp.
The Wall Street Journal -- July 19, 1999
Microsoft's Huge Cash Hoard Becomes
Big Weapon for Entering New Markets
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By David Bank
Staff Reporter of The Wall Street Journal
During the frenzied round of consolidation among Internet companies earlier this year, Greg Maffei, Microsoft Corp.'s chief financial officer observed from the sidelines that highflying stock seemed to be the currency of choice in such deals.
"Right now, cash is trash," Mr. Maffei said. "But just watch. Cash will be king."
It was a prophetic statement. While Microsoft has been making history with its market capitalization -- which topped half a trillion dollars Friday, pushing Chairman Bill Gates's net worth to a staggering $100 billion -- the software giant has turned its mind-boggling cash hoard into a powerful new weapon for establishing the Redmond, Wash., company in new markets.
Many Internet companies now have valuable stock to swap, but nobody can match Microsoft's cash clout. At the direction of Mr. Gates, President Steve Ballmer and Microsoft's board, Mr. Maffei has opened the company's checkbook for buying minority stakes in a range of cash-hungry cable and telecommunications companies. The company's $5 billion cash investment in AT&T Corp. in May, for example, was five times bigger than its largest previous investment.
It's an ominous development for competitors hoping to exploit shifts in technology or solidify their leads in new markets before Microsoft can enter. They now face a company with extraordinary spending power to reserve a favored position in the next round of competition.
"If you're Bill Gates or Steve Ballmer, this is a fabulous way to get your seat at the table," says Sanjiv Hingorani, an analyst at ING Barings Furman Selz. "They are trying to buy their way into potential future markets."
Microsoft's new aggressiveness in deploying its cash will be reflected in results to be reported today for the fiscal fourth quarter, ended June 30. For the first time in recent years, Microsoft's reserves of cash and short-term securities are expected to fall, to about $18 billion from $21.8 billion at the end of March. At the same time, the company is expected to report that its equity investments have roughly doubled, to $15 billion.
The temporary dip in Microsoft's account balance obscures the company's accelerating ability to generate cash. Thanks to fat profit margins and some clever financing practices, Microsoft's cash flow has more than doubled in the past two fiscal years and has increased nearly eightfold in the past four fiscal years.
"This is a machine," says Michael Kwatinetz, an analyst at Credit Suisse First Boston.
Indeed, behind the net-cash totals that have attracted attention are separate stacks of money that are piling up even more rapidly. "This company has a lot of hidden assets," Mr. Kwatinetz says.
The largest source of cash, of course, is the company's fat operating income. For the quarter ended June 30, Microsoft is expected to report net income of $1.9 billion, or 35 cents a diluted share, an increase of 40% from $1.36 billion, or 25 cents a share, a year earlier.
Microsoft has cash salted away in a number of other pots as well. Microsoft sets aside a portion of software revenue to cover upgrades and support costs. Even as such revenue from past quarters flows in, Microsoft sets aside additional "unearned revenues." In the first nine months of this year, the balance in the account grew by $1.31 billion to $4.2 billion.
Partly to cap that runaway growth, Mr. Maffei said last month the company will lower the percentage of revenue set aside as unearned. The change will slightly boost current revenue and earnings.
Microsoft has hidden pockets of cash as well. Microsoft doesn't report the size of its set-asides for revenue from software bundled into personal computers while it waits for a full accounting from PC manufacturers. Mr. Hingorani estimates this account contains hundreds of millions of dollars, though probably less than a billion.
"It gives them the flexibility to unlock the reserve when they needed to and not unlock them when they needed to," Mr. Hingorani says. "The goal is to smooth out earnings."
Such smoothing is anathema to federal regulators because it might mislead investors about the company's actual results. Last month, Microsoft said the Securities and Exchange Commission is investigating allegations the company used reserves to artificially smooth earnings. Microsoft executives deny the allegations.
The company did raise analysts' eyebrows in the fiscal third quarter when it used $350 million in gains from equity sales to partly offset a $400 million shortfall caused by delays in shipping its new suite of desktop software. "That's another form of smoothing," Mr. Hingorani says.
There's certainly plenty of leeway in Microsoft's bulging equity investments account. Under accounting rules, Microsoft reports only the original price of its investments rather than their current market value. For example, the account reflects the $1 billion paid for 11% of cable operator Comcast Corp. in 1997, rather than the stake's current value of more than $2.5 billion.
Recently, Microsoft's pockets have also bulged because it is falling behind in its never-ending effort to keep up with stock options exercised by employees. As of March 31, the market value of Microsoft's stock options outstanding was $72 billion. Microsoft buys back shares on the open market to give to employees exercising stock options. To pay for the shares, Microsoft uses the cash it receives from employees, who must cover the original issuing, or "strike," price of the options. Microsoft also gets a tax benefit for the difference between the strike price and the market price. In addition, Microsoft has a warrant program that helps finance its stock repurchases.
The financing program added $2.55 billion to the cash total in the first nine months of the year, a sharp reversal from the $501 million the efforts cost Microsoft as recently as fiscal 1997.
As Microsoft increasingly uses its cash for telecom investments, it is becoming clear that the company is transforming itself from an operating company dependent for growth on PC shipments to a hybrid operating-holding company with a long-term equity portfolio in communications infrastructure and services companies. "Microsoft is diversifying its risk away from the PC platform," says David Readerman, an analyst at Thomas Weisel Partners, a San Francisco merchant bank. "They're building annuity streams in the broadband networked world."
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