How Microsoft Can Avoid the HPQ Trap

By Eric Jackson
RealMoney Contributor
9/2/2010 5:00 PM EDT
Click here for more stories by Eric Jackson

Earlier this week, Hewlett Packard's (HPQ - commentary - Trade Now) board announced it was undertaking a $10 billion stock buyback. It plans on spending $3 billion of that this quarter. It only has $14-15 billion in cash on its balance sheet. And don't forget, it has just snatched 3Par (PAR - commentary -Trade Now) from the jaws of Dell (DELL - commentary - Trade Now) for $2.4 billion.

Investors cheered the news of the buyback. On the day of the announcement, an otherwise dismal trading day (unlike yesterday), HP was the only positive stock in the entire S&P 500. Wouldn't this suggest that buybacks are a great way to increase shareholder value? Well, to answer that question, in my view, you have to ask: great as opposed to what?

Of course, HP's decision to spend a big wad of its cash on buying its own stock is much better than what it was doing previously, namely:

Nothing, letting cash accumulate on its balance sheet, and

Trying to buy a company at a 200% premium.

Buybacks are also preferable to paying an enormous one-shot dividend to shareholders, as Microsoft(MSFT - commentary - Trade Now) famously did a few years ago when it shelled out over $3 a share. Why should shareholders hold on to a company's shares after they've gotten their lottery-ticket bonus? Should they hang around and hope that the lucky lightning will strike twice?

A much preferable alternative, which HP should have considered -- and which Microsoft's board still has the chance of choosing -- is to dramatically increase the regular quarterly dividend. What am I talking about? Isn't this all financial engineering? Stock buybacks versus dividends? Next, surely, I'm going to be talking about Modigliani and Miller and ideal capital structure?

Well, that is mostly likely the reaction of Microsoft chief Steve Ballmer and many senior executives at S&P 500 companies when this topic comes up. I'm sure Steve Ballmer becomes more frustrated than most on this topic, because he must believe that he's tried to do the right thing in the past to appease shareholders -- that famous one-time dividend and many buybacks and dividends -- and it hasn't worked.

....

[*** This post is an excerpt of the full article, available by clicking here to go to RealMoney.com. Note: subscription required. ***]

Sphere: Related Content