Microsoft Should Pay a Fat Dividend

Microsoft ( MSFT) is currently in the midst of what should be its new dawn as a company.

Bill Gates has left the building. It's Steve Ballmer's show to run the company, which is currently in a massive upgrade cycle with a new operating system (Windows 7) and a new Office suite of applications. Yet the stock is going nowhere.

Investors have been waiting for some time for Microsoft to get its act together. They're still waiting. Four years ago, David Einhorn said that buying Microsoft at $23 was like getting Alex Rodriguez for next to nothing in a fantasy league baseball draft. After last week, it's back at $23 again.

There are many things going right for Microsoft, and investors are hoping to hear about many of them on the July 22 earnings call. They're hoping to hear good things from Client, Office, the Business divisions and cloud computing, where Microsoft is making strides.

However, investors will have to do their usual holding of breath to see how Microsoft's Online Services group and Xbox products do. Did Bing gain another 0.2% in the quarter? This is gripping stuff.

On the other hand, with the merciful self-killing of the not-so-hip Kin phone a few weeks ago, don't expect much from Microsoft about its plans on branching away from the PC to mobile-connected devices. No, that's a war being waged between Apple ( AAPL), Google's ( GOOG) Android software, Research In Motion ( RIMM) and to a lesser extent Nokia ( NOK).

I never did understand the Kin (although I wasn't the 18-year-old in their demographic). The phone was supposed to keep me socially networked to all my friends just like every other phone can do. It looked like a pocket-sized circle, so maybe they thought they'd get points for modern art-like innovation.

But the coup de grace -- or so the phone experts at Microsoft thought -- was going to be the way the Kin phone made users dependent on going back to their PCs so they could manipulate all the data like photos, notes and updates that they created on their phones during the day.

That one product failure beautifully encapsulates the myopic biases that thousands of brilliant Microsoft engineers and management are wandering around Redmond withblissfully unaware. I have an image of Microsoft employees assembling for their morning calisthenics in a large courtyard chanting: "We are a PC company. Any new business we get into will be an adjunct to the PC business."

So what's a business whose stock price is down 42% over the last decade to do?

I used to think a transformative acquisition was the answer. If it bought an SAP ( SAP), a Research In Motion or a Yahoo! ( YHOO), it could make a big splash in any of those areas where it is currently lagging. Microsoft had the cash to do it, and starting tentatively over the last couple of years, it dipped its toes into the debt markets -- giving it access to even more cash to finance a future deal.

It seemed like the Microsoft brass agreed with this logic two and a half years ago when it sprung the buyout offer on Yahoo! Somewhere on the way to that deal getting consummated, Steve Ballmer changed his mind or asserted himself and went back to the Microsoft DNA: Not Invented Here -- which means "we'll build products ourselves or we won't compete in those areas at all."

So, as a long holder, I'm no longer expecting a big deal to juice the stock. In fact, at this point, I think one would spook investors. Any of those aforementioned deals would be now viewed by the market -- in my opinion --- as too big to integrate as well as being for companies whose best days are behind them.

So the obvious question is what should Steve Ballmer do if not make a big splashy deal that investment bankers would salivate over? He should run Microsoft like a bank -- not a modern basket-case bank with improper capital levels and a stack of bad loans. He should run Microsoft like an old-fashioned bank that expanded conservatively and paid out a fat dividend attracting lots of widows and orphans.

In other words, raise your dividend, Microsoft. It tried the one-time $3 special dividend a few years ago with no long-term impact -- except that it's made Ballmer bitter about it ever since. I'm suggesting the company raise the quarterly dividend.

Currently, at these levels, you're getting paid a 2.2% annual yield on Microsoft to buy it at $23. The yield on the 10-year note is currently 3%.

Doubling their dividend yield would cost Microsoft another $4.5 billion a year. However, it has $37 billion in cash on hand and is generating operating cash of $22 billion annually. And they have access to more debt if they need it.

Instead of decrying its lagging stock price, Microsoft should embrace it and pay a very fat dividend. They would find that many modern-day widows and orphans would be attracted to their stock as they were in the good old days when buy and hold was the dominant mantra.

At the time of publication, Jackson was long Microsoft, Apple and Google, and short Research In Motion.

Eric Jackson is founder and president of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson

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