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When Microsoft holds its annual meeting with Wall Street's bean counters on Sept. 14, investors' obsession with higher dividends for tech companies will be on full display.
I've written a bunch in this column about the hopes that Microsoft (ticker: MSFT) might increase its dividend yield from a little under 2.5% at present. The annual meeting is the time when Microsoft's board considers such options, and I have an expectation of an increase, but nothing dramatic; the payout was increased by 23% last year, and 18% the year before that.
But I don't mean to pick on Microsoft exclusively. The subject of tech shareholders' returns more broadly speaking was brought nicely into focus last week with a report from Morgan Keegan's Tavis McCourt, who has been a relentless voice for greater payouts.
McCourt, who argues that hoarding cash is "destroying equity value" in tech stocks, points out that despite better growth prospects than many industries, tech as a whole trades at a lower price-to-earnings multiple than many other sectors, including moldy old industrials.
With the highest cash balance of all the sectors he tracks relative to total capitalization, and some of the best earnings growth prospects, tech stocks also have the lowest valuation on average, by his estimation. Cash makes up on average 28% of tech companies' enterprise value, but the average P/E is just 10.4 times this year's expected earnings per share.
And the total return of tech stocks is 7.6% in the last 12 months, behind even utilities at 7.9%. No coincidence, McCourt suggests, that tech's average dividend rate is a measly 1.4%.
McCourt notes that even within tech, those paying out more have seen their shares outperform their peers.
"Over the past year, the high-dividend payers have outperformed with a total return of 10.4% versus 4.7% for the low-dividend payers," observes McCourt, "despite a much worse growth profile (2% expected EPS decline amongst dividend payers versus 9.7% growth amongst non-dividend payers.)"
The most perverse aspect of all this, in McCourt's view, is that large cash piles not getting paid out are being used to feed expensive acquisitions. While McCourt doesn't mention it by name, Google's (GOOG) $12.5 billion bid for Motorola Mobility (MMI) arguably fits into that category, even though Google and others would say it's actually a good deal.
Certainly a survey like McCourt's makes clear that the struggle between those investors demanding a payout and those companies willing to pursue mergers and acquisitions is increasing.
When Apple's (AAPL) Steve Jobs stepped down from the top spot two weeks ago, there was immediate speculation on whether Apple would institute a dividend or a share buyback. Such a move would entice value investors, some argue, giving the stock some added protection in the wake of his departure.
As I wrote in this column, I don't expect anything of the kind, not with Jobs serving as chairman of the company.
But the total cash and securities on Apple's balance sheet, now an astonishing $76.2 billion, sticks out like a sore thumb. Apple has been acquisitive in small ways over the years, nothing gigantic, and so just what can be the point of hoarding all that?
Apple generated an amazing $16.6 billion in free cash last year, which could have funded a buyback of 5% of Apple's market cap. Or, it could have been used to pay out $17.90 a share, for a dividend yield of roughly 5%.
Of course, these are extreme examples, not meant as a suggestion so much as an illustration of the tremendous potential for Apple to return cash, even if the company never touched the money that's already in the bank.
IT'S NOT JUST THAT INVESTORS are restive about the cash. The "animal spirits" of the buyout community are in the air, with a variety of names floated as targets. These targets wouldn't serve "strategic" purposes; rather, they are the kind that private equity likes to buy, restructure and sell.
One such rumor making the rounds last week was AOL (AOL), the online service that is now a mere shadow of its dot-com self. A report by the New York Post had the company huddling with bankers to consider going private. Kohlberg Kravis Roberts (KKR) is one of the rumored suitors.
AOL, which has lately become a major online content publisher (it owns things such as The Huffington Post) is mostly of interest for its original business: connecting millions of people to the Internet for a monthly fee.
Believe it or not, AOL continues to make a substantial amount of money off that "access" business, which UBS (UBS) analyst Brian Fitzgerald estimates will total $732 million this year, or roughly one third of total company revenue.
In a note published last Wednesday, Fitzgerald writes that there is "hidden value" in AOL. Although the access revenue is set to decline by 23% this year, and by the same amount next year, what is there costs little to maintain, and so it is a cash cow, he points out.
With a very high pre-tax profit margin of 79%, and minimal capital requirements, the AOL access business will bring in close to $600 million in free cash flow this year, points out Fitzgerald. That represents $12 per AOL share; the closing price of the stock on Friday wasn't much higher, at $14.50.
Fitzgerald calculates the total sum of the parts for AOL, not including the dial-up modem business, is close to $20. Whether or not it's that valuable, it's certainly possible that the presence of a cash machine in the access business has got to interest some parties willing to make an offer for AOL and restructure the thing, perhaps selling off the access business to someone who can make better use of those cash flows.
I would never advise anyone to chase buyout prospects, as uncertain as they are. But there may be something to these speculations. They are of a piece with the theme at the top of this column: cash, lots of it, lying around, with nothing to do.
In the end, we're more likely to see a frenzy of buyouts than we are to see dramatically higher payouts, I should think.
The Nasdaq Composite Index clung to a half-point gain to finish the week flat, but it was enough to outperform the other benchmarks, which declined.
Tiernan Ray can be reached at tiernan.ray@barrons.com or at blogs.barrons.com/techtraderdaily or www.twitter.com/barronstechblog
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