Moody's Rates Microsoft's (MSFT) Proposed Notes Offering at 'Aaa', Outlook Stable

Moody's Investors Service, (Nasdaq: MSFT) assigned a Aaa rating to Microsoft's proposed senior unsecured debt offering. The rating outlook is stable.

RATINGS RATIONALE

Microsoft recently announced that it plans to complete the remaining $31 billion share buyback program by the end of December 2016. Similar to many global technology companies, absent US tax reform or the implementation of sustainable legal organization and/or tax strategies that shift the geographic recognition of revenue, profit, and cash flow, Moody's believes that Microsoft's dividends and share repurchase activity could be constrained over time unless incremental debt is raised. Doing so could result in ratings pressure.

While Microsoft has significant liquidity, only $8.1 billion is reported to be maintained domestically. Despite our expectations of softness in consumer PC demand over the next year, we anticipate Microsoft's range of enterprise software will contribute to about $36 billion of cash flow from operations over the next year, about half of which will be generated internationally. After considering our estimate of $6 billion of capital expenditures to build out its global data center footprint and $10 billion of dividend payments, we project about $20 billion of free cash flow over the next year. Because all common dividends and about half of capital expenditures occur domestically, we project Microsoft's domestic free cash flow (after dividends) approximates $6 billion to $8 billion annually.

The maintenance of very strong liquidity ($90 billion of cash and liquid investments as of December 2014) and low financial leverage provide the company with substantial financial flexibility to invest aggressively and persistently in order to defend and grow its core business position and address competitive challenges. Over the next year, Moody's estimates adjusted debt to EBITDA of about 1.0 times, free cash flow to adjusted debt of over 50%, and after tax cash less debt of nearly $40 billion.

Microsoft's Aaa senior unsecured rating reflects the company's position as the world's largest software company with a strong, leading market share for its core products that make up over 80% of revenue. With its substantial financial strength along with strong recurring revenue streams, high customer retention rates due to high software switching costs and long product life cycles, the company is well positioned to address challenges related to technology evolution and substitution (through acquisitions and internal investments) as well as its exposure to periodic litigation risk. Some of these challenges include the growing adoption of cloud-based and mobile computing devices, some of which are based on non-Microsoft software, and potential incursions that could be made into its operating system and productivity software market position over time.

Management's historically very conservative financial philosophy is an important underpinning to the Aaa rating. Over time, if Microsoft raises debt and increases leverage to support its capital allocation program, the rating could come under pressure. The ratings could face downwards pressure if there is deterioration in the company's core business model that results in a material, sustained erosion in its very strong market positions, profitability or cash flow generation.

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