Microsoft will issue debt to purchase Linkedin. We learned that this month along with the nuances of tax repatriation. A lot in taxes will be paid if Microsoft buys Linkedin with overseas cash. Most of Microsoft’s $107 Billion in cash and cash equivalents are held outside the United States. But to avoid taxes, Microsoft could have use stock to purchase Linkedin.
Overseas cash wasn’t a problem in the past when Microsoft acquired Nokia, Skype, and recently Mojang Synergies (Minecraft). All those acquisitions were done, not with stock, but with cash: $3 Billion for Mojang, $7 Billion for Nokia, and $9 Billion for Skype. Using cash made sense, because all three companies were overseas and so need to repatriate any cash. Now Microsoft will do the same, buy Linkedin with cash.
The tech press touted the sheer genius of Microsoft: the interest on the debt is tax deductible! Yes it could be, but it really isn’t that much. Last November 2015, Microsoft issued $13 billion in debt, paying an average interest rate of 3.00%. Using the same interest rate means Microsoft will pay $780 million in interest expense to acquire Linkedin. But since Microsoft’s effective tax rate is 27%, the tax deduction is only $210 million per year.
Generally, the tax department is not a profit center. Microsoft makes money selling software and services; tax savings are extra. From a financial perspective, Microsoft is just moving cash from overseas to here. In the end, Microsoft breaks even. Interest income earned overseas is offset by the interest paid on newly issued debt. In fact and surprising, a majority of the overseas cash is invested U.S. government and affiliated debt, which may not pay the highest rate.
Taxes aside, the biggest surprise is that any of this is news. In its annual report, Microsoft said it will continue to use debt, instead of repatriating cash, as long as interest rates remain low (Liquidity Section of the 2015 Annual Report). In addition, Microsoft said back in November 2015, that the $13 billion debt offering could be for the following (italicized):
Microsoft intends to use the net proceeds from the offering for general corporate purposes, which may include, among other things, funding for working capital, capital expenditures, repurchases of capital stock, acquisitions, and repayment of existing debt.
Instead of cash, Linkedin could have taken stock. Maybe Reid Hoffman didn’t want stock, despite the tax savings to him of receiving stock instead of cash. Maybe Microsoft just wanted to use cash or maybe, as Microsoft said, issuing stock would result in a “dilution of our earnings” (See Liquidity Section of the 2015 Annual Report)
More stock lowers Microsoft’s stock price, which it doesn’t want. In fact, Microsoft has been doing the opposite. Borrowing IBM’s strategy, Microsoft has been buying back its stock. By reducing the supply of stock and increasing earnings per share, Microsoft magically increases the stock price for a company that is no longer a growing one.
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