Fitch Rates Microsoft's Note Offering 'AA+'; Outlook Stable
Fitch Ratings has assigned an 'AA+' rating to Microsoft Corp.'s (Microsoft) senior unsecured note offering. The Rating Outlook is Stable.
The ratings and Outlook reflect the following:
--Fitch anticipates modest revenue growth in fiscal year 2013 as the launch of Windows 8 and continued strength in the Server and Tools segment will be offset by macro headwinds and declines in PC unit volume in 2012. Fitch expects new PC product launches such as ultrabooks and hybrid PC/tablets will be successful and strengthen Microsoft's competitive position relative to Apple.
--Fitch expects the launch of the Surface tablet, particularly the Pro version, to be a commercial success given its compatibility with Microsoft Office applications, enhanced security and easier manageability, given the existing Windows installed base. However, free cash flow (FCF) contribution will likely be minimal in 2013, given the initial lack of scale and highly competitive landscape for tablets.
--Fitch believes Microsoft's position in the mobile phone market has improved in the past year due to Windows 8 licensing agreements with the vast majority of Android device manufacturers and original design manufacturers. Microsoft revenue is estimated at $5 to $15 per phone. While some market share gains are likely in the mobile phone market, the extent of the gains are highly uncertain, and the ratings do not factor in any meaningful free cash flow contributions from these products.
--The company's Online and Entertainment & Devices segments (Bing, Xbox, Skype, Windows Phone, etc) will continue to be a drag on profitability over the intermediate term. These segments remain a critical component of Microsoft's longer-term strategy in the consumer market, however, competition remains fierce and Fitch does not expect these segments to contribute materially to FCF for the foreseeable future.
--Fitch expects Microsoft to continue to produce strong FCF, in excess of $15 billion per year, which the company utilizes to fund its share repurchase and dividend programs. Fitch expects cash generation from operations to be strong enough to pay for modest annual increases in both dividends and share repurchases over the next several years excluding potential for meaningful acquisitions. Fitch expects all repurchases will be done within the context of FCF.
--The company's sizable liquidity and superior credit profile provide a significant degree of financial flexibility within the current ratings. Going forward, Fitch believes Microsoft will become more active with acquisitions and share buybacks over time but continue to maintain a significant net cash position.
--Absent broader corporate tax reform, Fitch does not expect any negative outcome from Microsoft's recent tax hearings with the Senate Permanent Subcommittee on Investigations.
--Leading market positioning in its core software businesses, including over 90% in PC operating systems (OS) and 75% in servers.
--Very strong balance sheet with $66 billion in cash and short-term investments. Microsoft generates nearly $1 billion in pretax income from interest and dividends alone.
--Diversification of end market with consumers and enterprise demand as well as strong geographic diversification. No customer is larger than 10% of revenue.
--Reliance on Windows and Office for vast majority of FCF and potential high correlation between the two business segments if alternative operating systems take meaningful PC market share. Microsoft's Windows and Office segments account for approximately 90% of total EBIT.
--Growing popularity of other operating systems outside of the core PC space, principally Apple's iOS as well as Google's Android and Chrome platforms. Fitch believes both platforms will continue to grow as competitive threats to Windows.
--Extensions of PC replacement cycles due to the popularity of tablets and smartphones.
--Minimal historical success in developing profitable businesses outside of Microsoft's core Windows and Office ecosystem despite significant investment over a decade-plus in other consumer markets which Fitch believes is indicative of the challenging competitive environment Microsoft has targeted.
--Significant dividend and share repurchase programs, although funded entirely today by FCF, could pressure the company to issue increasing amounts of debt to avoid repatriation of foreign earnings, which represent the majority of total annual FCF.
WHAT COULD TRIGGER A RATING ACTION
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
--Penetration of alternative operating system's such as Chrome OS in the PC market and/or greater market share gains by Apple.
--Greater than expected extensions of PC replacement cycles due to tablets, without a commensurate gain from Microsoft Surface. Fitch currently expects PC replacement cycles to extend on average up to 12 months.
--Greater acceptance of cheaper software applications that compete with Microsoft Office such as Google Docs.
Positive: Upside movement on the ratings is unlikely.
Additional information is available at www.fitchratings.com. The ratings above were unsolicited and have been provided by Fitch as a service to investors.
Applicable Criteria and Related Research:
--'Corporate Rating Methodology' (Aug. 8, 2012);
--'Rating Technology Companies' (Aug. 9, 2012).
Applicable Criteria and Related Research:
Corporate Rating Methodology
Rating Technology Companies
John Witt, CFA
One State Street Plaza
New York, NY 10004
Jamie Rizzo, CFA
Brian Bertsch, +1-212-908-0549