Fitch Affirms Microsoft at 'AA+/F1+'; Outlook Stable

Fitch Ratings has affirmed the following ratings of Microsoft Corporation (Microsoft):

--Long-term Issuer Default Rating (IDR) at 'AA+';

--Senior unsecured revolving credit facility (RCF) at 'AA+';

--Senior unsecured debt at 'AA+';

--Short-term IDR of 'F1+';

--$2.25 billion commercial paper (CP) program at 'F1+'

The Rating Outlook is Stable.

The ratings and Stable Outlook are supported by Microsoft's: i) leading market position in its core software businesses, including over 90% in PC operating systems (OS) and 75% in servers; ii) industry leading liquidity, supported by a considerable cash position and consistent strong free cash flow; and iii) unparalleled financial performance and operating profile, complemented by a sizable recurring revenue base.

The company's sizable liquidity and superior credit profile provide a significant degree of financial flexibility within current ratings. Fitch believes Microsoft will become more active with acquisitions and share buybacks than it has been during the economic downturn, although overall activity is expected to remain conservative relative to the company's total liquidity and free cash flow profile. Fitch expects the company to continue to maintain a significant net cash position. Nonetheless, the company has ample capacity for significant acquisition activity, particularly given its large cash balance. Fitch expects all stock repurchases will be completed via available cash balances and free cash flow generation. Microsoft has $33.1 billion remaining under its current share repurchase authorization that expires in September 2013.

At Sept. 30, 2009, total liquidity consisted primarily of $33.5 billion of cash and investments, excluding $3.3 billion of securities pledged as collateral by borrowers in its securities lending program. This is comprised of $8.8 billion of cash and cash equivalents, and $24.6 billion of short-term investments, which are invested in highly liquid fixed-income securities. The company also has $6 billion of long-term investments, consisting of primarily public and highly liquid equity securities. Fitch believes a significant portion of Microsoft's cash is located outside the U.S. and will represent an increasing percentage of the total cash position due to stronger growth in international markets and continued funding of share repurchases and dividends with U.S.-based cash. Liquidity is further supported by Microsoft's industry-leading annual free cash flow, which Fitch estimates will be approximately $13 billion going forward. The company's undrawn $2.25 billion RCF maturing November 2010 serves as a back-up to the CP program.

Despite its strong industry position, Microsoft has experienced cyclical operating weakness in recent quarters, driven by anemic PC demand and reduced corporate IT spending. Fitch expects a modest improvement in operating results in fiscal year 2010 (FY2010), driven by a slightly better demand environment, particularly for PC unit sales growth from the introduction of the new Windows 7 OS, as well as continued cost efficiencies. Nonetheless, continued weakness in line with recent quarters would be well within current ratings, given the still unparalleled profitability, free cash flow, and credit protection measures.

Although Microsoft's software licensing revenue model currently faces various competitive pressures, Fitch does not believe there are any near-term threats or financial risks that would place the company outside of current ratings. That said, longer-term rating concerns consist of: i) new software models that could challenge Microsoft's highly profitable model, including open-source software, software as a service, or advertising-supported software; ii) gross margin pressures attributable to investments in and stronger growth of products/regions with lower average selling price (emerging markets, netbooks); iii) substantially lower operating margins for the Online Services and Entertainment & Devices Divisions, which represent nearly 20% of total revenue; and iv) further legal and/or regulatory actions that could impede the company's course of business. Fitch expects higher international growth and the ongoing expansion into adjacent businesses will continue to pressure margins, but are unlikely to materially affect free cash flow.

Microsoft remains subject to various lawsuits and instances of regulatory scrutiny, and currently faces up to $3 billion of payments and fines should all pending issues result in adverse outcomes (not including the ongoing European Commission objection to the inclusion of web browsing software with the OS, the financial impact of which cannot currently be reasonably estimated). Fitch views this contingency as manageable considering the company's significant free cash flow.

Total debt at Sept 30, 2009 was $6 billion and consisted of i) the fully drawn $2.25 billion CP program; ii) $2 billion 2.95% senior unsecured notes maturing June 2014; iii) $1 billion 4.20% senior unsecured notes maturing June 2019; and iv) $750 million 5.20% notes maturing June 2039. Fitch expects Microsoft may seek to increase debt in the medium term to replenish its U.S.-based cash balances in order to continue funding stock repurchases, cash dividends, or acquisitions without repatriating offshore cash subject to incremental taxes. Fitch believes the company has financial flexibility to issue significantly more debt over the intermediate term, particularly to deal with cash location issues, as the company maintains its net cash position.

Additional information is available at www.fitchratings.com.

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