What could be interesting for the likes of Microsoft and Amazon over the next couple of days will be the outcome from the OECD talks on the creation of a multilateral digital tax system, to ensure fair tax practices. According to the organisation’s Secretary-General, Ángel Gurría, there could be the risk of “a cacophony and a mess” if a global agreement is not reached. Close to 140 countries are set to gather for the two-day meeting, which is expected to result in the largest modernisation of international tax rules since the 1920s. Microsoft President Brad Smith supports the need for a change in the taxation system, saying, “it does make sense for big tech companies to pay appropriate taxes”.
Valued at USD 1.278tn, currently, Microsoft is the second most valuable technology stock after Apple. Just after the US market close yesterday, the software giant released its latest quarterly earnings and it appears as though there is certainly more room for its stock to rally this year. Quarterly sales smashed through analyst estimates by over USD1bn and revenue rose 14% (USD36.9bn); driven by the surge in corporate demand for Microsoft's cloud-based systems. Revenue from its rapidly growing Azure cloud-computing services rose 62%; the company has captured the second largest market share within the sector, after Amazon. However, it beat Amazon to secure a USD10bn cloud contract with the Pentagon; revenues from which we expect will filter through over the next few years. Microsoft’s Productivity and Business Processes division also supported revenue growth. The software giant did, however, give a wider forecast than previously for the More Personal Computing business following concerns over coronavirus and the potential effect on PC manufacturers in China.
Microsoft paper is currently one of the few sufficiently liquid options for high rated (AAA/AA+) corporate paper, as a complement or alternative to UST holdings. Bonds such as Microsoft 4.5% 2037s have moved in-line with the recent US Treasury rally; gaining 4 points so far this year (at time of writing), this follows the +18.72% return last year. Our proprietary Relative Value Model calculates that the USD 2.5bn issue maturing in 2037 offers a yield and return close to 9%, with the added protection of ~4.8 notches of cushion. By way of comparison, the Republic of Philippines 5% 2037s has a similar ~12 year duration, but is rated Baa2/BBB+, so, one would therefore expect this bond to offer more in the way of return. However, we calculate that this bond is trading expensively, with the market actually pricing it as a Baa1/BBB credit (1.2 notches expensive) and the bond is priced to suffer a capital loss of 5 points if it were to trade at fair value. Whereas, the aforementioned Microsoft bond could make as much as 8 points in capital appreciation if it were to move to fair value; we know which we would rather hold.
Being unconstrained by benchmarks, and instead having a total return focus to bonds from “wealthy” nations, allows us to avoid investments in the most indebted nations in the world. We can therefore sidestep exposure to “expensive” bonds such as the Philippines 2037s across our strategies.