August 21st, 2006
Would Microsoft make a good private equity play?
I’m not sure what they are smoking at The Financial Times today, but it’s produced a hallucinogenic $288 billion in unrealized value that Microsoft is failing to deliver to investors. That is, value that would be extracted from the assets if the company were acquired in a leveraged buyout by private equity bankers who would leverage the company to the hilt, cut costs and staffing to the marrow and generally do violence to the lumbering giant.
Consider, the FT says:
The new management could take the axe to Microsoft’s $6.6bn of wasteful research and development expenditure. The bloated workforce of more than 60,000 could be slashed, to the point where the huge resulting increase in cash flow would at last permit the company to borrow mega-billions.
This brings us to the real joy of private equity: the so-called “dividend re-cap”, a dividend-for-debt swap. The enhanced ability to borrow would permit the newly private company to make the greatest dividend payment of all time. At a stroke it would solve the financial problems of the army of private equity investors who have been trying – hitherto unsuccessfully – to punt their way out of pension fund deficits. Here, going begging then, is a great historic opportunity for private equity to do its job of generating excess returns from illiquidity. In truth, Microsoft would be worth more off the quoted market than on it. Thanks to the joys of leverage and dividend recaps, the excess returns would come through wondrously fast.
Ah, I hear you say, but what about the exit strategy? How, in the brutal jargon of the trade, could Microsoft be flipped? Simple. With such a humungous dividend recap, who cares about an exit strategy once the dividend is nestling comfortably in investors’ pockets?
In other words, gut the company, take the money and run.
It’s a scenario that fails to recognize that the massive investment at Microsoft is in relationships: With customers and ISVs who, sensing the end of Microsoft as the safe bet for IT managers to do business with ("We don’t have to worry about getting sign-off on a Microsoft deal, the company will be around forever.") would bolt for the door as fast as possible. What people seem to do is make some company in each generation the indispensible, bloated white-shoe firm that, despite all its backwardness, shucking and jiving business practices, exists on the web of relationships that can be purchased with lunches and sweetheart deals. During the 1960s and 1970s that company was IBM.
Firing everyone in Redmond would erode the asset value of Microsoft, which depends on repeat revenue to produce the "wastefully" profitable results the FT decries. I know we’re all about efficiency in this capitalist economy, but the ruthlessness of private equity banking is a kind of mythical creature that only appears once in a great while and doesn’t always deliver the results promised.
You have to believe that Microsoft’s parts are worth more than the whole, but I don’t think anyone believes Windows and Office aren’t deeply intertwined and that SQL Server and Exchange Server don’t depend on the proliferation of Windows clients. The dependencies—inefficinient though they are—is what makes Microsoft valuable.
I’ve criticized Microsoft for its mispresentation of its R&D spending, but the FT article fails to take into account that almost all that expense goes into product, not basic research. In fact, Microsoft sexes up its lumbering business by calling most of its development efforts R&D when it is really just a software factory.
Unlike an automobile factory or a physical supply chain, though, Microsoft has almost no assets that can be sold off without dramatically reducing the value of what remains. The leveraged buy-out is predicated on the idea that assets can be put to better use. Microsoft monopolizes as much talent as it can, so that its competitors can’t outdeliver its products (at least, by version 3, when the Microsoft tortoise usually catches the proverbial hares, from Apple, to Netscape to….) Holding so much value captive is the only thing preserving Microsoft’s value.
The move would be tremendously good for open source software and Apple, as well as hardware vendors who are ready to or already have jumped to Linux. But it would devestate the whole value chain, from the Microsoft campus in Redmond to every Windows-dominated retailer in the world. And the cost to everyone other than the bankers and investors who cleaned up on the one-time dividend the FT contemplates would offset any gains to the IT market by a long shot.
Gradual change is already well underway. The end is nigh for Microsoft’s total domination of the IT industry. That was confirmed by Bill Gates’ pre-announced departure from day-to-day involvement in the company earlier this summer. If gutting the company is the solution now, even if the price is the gutting of the IT industry, then let the bankers begin. I think we need the time to change, not just change for change’s sake, if the result will not be Just Another Monopolist for the next generation.
Mitch Ratcliffe is a veteran journalist, media executive and entrepreneur. See his full profile and disclosure of his industry affiliations.
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| 08/21/06
