Make it rain

By Pascal-Emmanuel Gobry on September 18th, 2013

A persistent question dividing shareholders and managements of companies is what they should do with their cash. This is a persistent question for technology companies.

In economic and financial theory, a company should not send cash back to shareholders if it can obtain a higher yield for that cash than the shareholders get from holding the company’s stock. In other words, if shareholders expect your stock to return 7 per cent per year, and you can buy a company or introduce a new product and get a return on investment of 10 per cent per year, you should do that.

By contrast, if a company can’t find more remunerative uses of its cash, it should send it back to its shareholders, so that they can find better uses for it.

For technology companies this is always a thorny question, because successful technology companies tend to accumulate such a gigantic cash stockpile that it’s hard to see how they could profitably invest all of it. It’s a particularly important question for declining technology companies, since the record of declining technology companies spending their way back into relevance is so poor.

Shareholders of those companies are therefore not unreasonable in thinking that if the company doesn’t send the money back, it will simply piss it away.

All of which brings us to Microsoft, which has recently announced a massive $40 billion stock buyback. Microsoft is the poster child for the idea that declining technology companies should just milk their existing business, send as much cash as possible to the shareholders, and decline peacefully.

Instead of being destroyed on fruitless ventures, that cash will be circulated back into the economy, where it can find productive investments. Besides, not doing that is a kind of theft of the shareholders, since it is their money, and they invested it in the company to get a return, not to enable the empire-building fantasies of fatuous CEOs struggling for relevance. Again, when you look at the billions Microsoft has burned on Bing for no progress, this perspective is appealing.

Which is is well and good. But there’s actually a pretty good case that what Microsoft should do is the exact opposite: it should take its $40 billion, and make crazy bets with it. It should keep doing things like funding Bing, and buying Skype, and selling tablets as a loss, and all the rest.

Why? Because crazy bets make society better off. Look at Bing: Bing has been a disaster for Microsoft, but it’s been a boon to society, providing welcome competition to Google, who would have a monopoly on search if Microsoft weren’t so single-minded in its fanatical quest to beat Google.

Look at all the cool stuff that Microsoft Research is working on. It’s working on using technology in education, human-computer interaction, and even HIV vaccines. Isn’t that great? If the history of big corporate research parks is any indication, Microsoft shareholders will never see that money again, but it doesn’t mean Microsoft Research’s work won’t make the world a better place some day.

And there’s another reason: crazy bets sometimes pay off.

Remember when Microsoft invested in Facebook at a $15 billion valuation and everybody thought that was ridiculous? The thinking inside Microsoft was probably also that it was ridiculous, but that the cash wouldn’t make any difference to them. And now, not only has that investment been much more profitable than investment in Microsoft stock over the same period, it has also been great for Microsoft’s position in the marketplace, paving the way for all sorts of interesting partnerships with Facebook against their common enemy, Google.

When a shareholder invests in a declining asset, they’re not investing in much, because the net present value of future cashflows is, by definition, pretty low. But investing in a portfolio that includes a large declining asset but a lot of deep out-of-the-money calls (risky bets that could pay off handsomely) is an interesting proposition. So shareholders, and not just society and overpaid Microsoft management, might win.

And of course, there’s another constituency that wins: people like me who make money writing about the crazy things technology companies do.

So go, Microsoft. Piss it all away, and have fun. It’s the right thing to do.