Article 5.4 Microsoft beats Apple in the credit ratings league

By Michael Mackenzie and Vivianne Rodrigues

Financial Times May 1, 2013

It is a long standing rivalry and on one score, Microsoft still trumps Apple - when it comes to the rating of their respective debt securities.

In contrast, Microsoft is rated Triple A by both Moody’s and Standard & Poor’s. Fitch, which has not yet rated Apple, assigns a Double A plus rating to Microsoft.

This comes in spite of Apple having an enormous gross cash pile of $145bn, and enjoying solid sales for its very popular products. While that would suggest Apple should qualify for a top rating, it has been awarded a slightly lower rating due to its hefty reliance on sales to consumers. The rating agencies deem this market to be more volatile than sales to corporate customers.

In turn, the Triple A club has a very select membership of just four US companies, ADP, Johnson & Johnson, ExxonMobil and Microsoft. What links these companies, say analysts, is their strong leadership in their respective sectors.

‘Generally, Microsoft has a recurring fee business, while Apple is more of a con­sumer products company,’ says Jack Ablin at Harris Private Bank.

Gerald Granovsky at Moody’s says: ‘Microsoft’s ratings reflect our confidence in the company’s revenue stream and also the fact their customers have very little option but to buy Microsoft products. The consumer profile for the companies is slightly different.'

He adds: ‘Apple's credit profile is tied to the company's ability to keep up with innovations and maintain its unique corporate culture. The rapid rise and fall of new products demonstrates these sectors are particularly prone to transforma­tional changes that could lead to shifts in market leadership.'

Fitch said the company would likely fall in the high single ‘A' rating category, based on the inherent business risk of consumer-centric hardware companies.

‘Consumer product companies such as Sony, Nokia, and Motorola Mobility have proven the risks related to ever-changing consumer tastes, low switching costs, and a highly competitive environment,' said James Rizzo at Fitch. ‘Each has his­torically had a dominant market position and strong financial metrics, only to falter over a relatively short period of time.'

‘Apple's better diversification and the stickiness of its iTunes ecosystem clearly make it a stronger credit that would likely be at the highest end of the ‘A' category,' said Mr Rizzo.

While there is a one notch difference in ratings between Apple and Microsoft, investors appear less discerning based on the pricing of recent bond issues by both companies. Apple's blockbuster bond issue priced very close to where Microsoft's much smaller $1.95bn offering of five-, 10-, and 30-year debt was sold last week.

While Microsoft sold $1bn of 10-year debt at 70 basis points over Treasury yields, Apple's $5.5bn issue arrived at 75 bps over benchmark government debt. There was a difference of 10 basis points in pricing between their 30-year bonds.

FT

Source: Mackenzie, M. and Rodrigues, V. (2013) Microsoft beats Apple in the credit ratings league, Financial Times, 1 May.

A checklist for a rating assessment might include:

• breakdown of sales by geography and product lines - degree of diversifica­tion is of particular interest

• market position of main goods and services produced, pointing out competi­tive advantages

• life-cycle position of main goods and services: are they old, tired or in decline?

• costs

• sources of inputs: any competitive advantages or weaknesses there, e.g. reli­ant on one supplier for a key input

• intellectual property ownership (trademark, copyright, advantage given by government or regulatory concession/licence)

• any restriction on price charged, e.g. under competition authority rules or other regulators

• excessive dependence on one/few customers

• thought-through strategy or changed by whim at short notice

• vulnerability to technological change

• main drivers of profits and cash flow

• managers' track record

• delivery on past plans

• risk management processes

• plans for further cash raising, equity or bonds; how receptive might the markets be; will the changes unbalance the capital structure, creating risk?

• how sensible the dividend policy is

• any worries over the legal structure of the group, such as subsidiaries in overseas companies borrowing, government controls on moving money across borders

• contingent liabilities, e.g.

• strength of bank relationships

• derivative risk exposure.

The sovereign issuer might be asked for the following:

• national economic and financial data

• government budget forecasts

• independent reports on the country, e.g. from the International Monetary Fund

• economic strategy, e.g. fiscal policy, monetary policy, planned privatisa­tions, microeconomic reforms, exchange rate policy

• political trends and risks

• general government debt burden

• government debt owed to foreigners (external debt)

• taxation powers

• strength of political institutions and trends

• contingent liabilities

• private sector external debt (owing to foreigners) burden.

As well as specific bond ratings the CRAs provide issuer ratings to firms and other organisations, which are assessments of the creditworthiness of the whole entity. The vast majority of ratings, however, apply to a particular security issue by the firm. Ratings on some securities may have a higher rating than the issuing company as a whole because the specific security is secured on a very reliable asset.

Obtaining a rating can be expensive, of the order of 0.05% of the amount raised with a minimum of $80,000, but for some companies the benefit of being able to borrow at lower interest rates due to the rating can be worth ten times as much as the fees paid for it. For other companies the equation does not work out that way and they choose not to obtain one - see Article 5.5.

If a bond does not have a rating, it could simply mean that the borrower has chosen not to pay for one, rather than implying anything untoward or sinister. Indeed, some bonds are sold on a name recognition basis, that is, the issuer has such a good reputation with lenders accepting that their financial standing is such that there is a very low likelihood of default and they do not require a formal credit rating. However, ‘unrated' is often used to mean poorer default risk.