Why Microsoft is Buying LinkedIn with Borrowed Money

Why Microsoft is Buying LinkedIn with Borrowed Money

Microsoft announced it wants to buy LinkedIn for $26 billion and indicated they will borrow to fund the acquisition.

At present Microsoft has over $100 billion in cash and cash equivalents, so borrowing might not seem necessary. However, much of their cash is in offshore accounts. Bringing it into the United States would generate a tax bill. The borrowing is, therefore, equivalent to a tax-free “repatriation.” U.S. businesses are taxed here on worldwide income, but only when it is “brought into the U.S.” Leaving it offshore also enables the profits to be further invested earning more U.S. tax-free income. In effect, maintaining the funds overseas creates a deferral of taxes at rates that could exceed 40%. Tax deferral is a valuable and widely used benefit. “Brought into the U.S.” means that the funds are deposited into accounts controlled by the parent. While Microsoft’s foreign subsidiaries control the funds [even though Microsoft as the parent actually controls those subsidiaries] that doesn’t constitute control for these purposes. And to top it off, much of the investments are kept in U.S. banks and brokerage accounts by the foreign entities.

Other reasons for Microsoft to borrow are:

• Interest payments would be tax deductible reducing the overall cost of the borrowing
• The interest rate they would pay would be expected to be lower than the return on their portfolio assets, so in effect they are using borrowed money to invest elsewhere at higher returns
• If Microsoft invests in U.S. stocks much of the dividends received would be 70% tax free creating an arbitrage between the borrowing and investments
• Microsoft currently pays a dividend yielding its stockholders over 2.8%. To the extent excess U.S. cash is used to buy back outstanding shares, dividends won’t have to be paid on those repurchased shares. Using borrowed funds at an assumed rate of 4% tax deductible interest to buy back shares paying a nontax deductible dividend of 2.8% will actually provide a cash flow profit to Microsoft
• Strategically having cash makes you king as long as the debt service is manageable. Also, there is a funny thing about credit – it is very hard to get when you need it, but very easy when you do not. Microsoft comes out a winner on this.

There are some downsides. The borrowing and inaccessibility of the offshore cash might affect their credit rating increasing interest that is paid. Also, the LinkedIn acquisition could turn out bad and/or they could have grossly overpaid – which time will provide the answer to.

Many times corporations seem to do some illogical or inauspicious things. Sometimes they are wrong, but keep in mind that they have some very smart people working for them and some excellent outside advisors who spend substantial amounts of time figuring out these things. In this case, it looks like a winning maneuver.