Microsoft Has A Higher Credit Rating Than Apple

And more importantly, Microsoft pays a lower interest rate than Apple on their bonds. What the bond market is saying is that Apple has a greater chance of defaulting on their debt then Microsoft. Let’s discuss why this might be.

Apple’s $145 Billion in Cash Fails to Win AAA Debt Rating

Microsoft Sells $2.67 Billion of Bonds With Record Euro Coupon (i.e., the lowest interest rate ever denominated in Euros)

Credit Risk

The risk that a company might default on their debt is credit risk. In assessing such risks, the buyers of bonds consider a multitude of factors like the quality of management, customer relationships, the nature of the business, the balance sheet, etc. But the granddaddy of them all is sometimes called a “moat” or “economic moat.” Professionals use the phrase “durable competitive advantage.” This is defined as a company’s ability to earn a high return on invested capital years into the future. Capital invested is the cost structure of the company; salaries, factories, R&D, real estate, marketing, etc. And the return, we know, comes from sales minus the costs. How is it possible that the market assigns a greater risk to Apple then Microsoft?

Economic Moat

As we know here in The Verge forums, the focus is on Apple’s lead in the consumer space. And we also know that The Verge loves Apple (nothing wrong with that), see iTunes Store at 10: how Apple built a digital media juggernaut. But what is the bond market thinking that The Verge is missing?

As Nathan pointed out in the article above, in the past iTunes dissed the competition, one after the other. The problem with iTunes, as I see it is twofold. First, the future will not be the past. There is real competition this time: Amazon music, Amazon Prime, Hulu, Netflix, Vudu, Google Play, Google Music, Twitter Music, Pandora, Spotify, and on and on and on. (Oh, and I forgot Xbox is now delivering movies and music, and it's no PlayForSure.) Second, and this is the big one, iTunes is a one trick pony. Without it's halo, Apples durable competitive advantage for the entire company is at risk.

iTunes is Apple's core. It binds the company's products and it's earning power. If it hurts, so will the company.

Let's compare iTunes to Microsoft Office. Despite what techies think, the enterprise needs office. How much money has Google Docs brought in since it's inception, a few millions. Office 2013 already pulled in a billion dollars, and that's in a few months. That's economic moat. If you're going to make a comment like "No one needs Office anymore" you just don't get it. Hundreds of millions of people do need it, it's built into their enterprise infrastructure, and it's cheaper and safer then switching to lower priced alternatives. Do you think Lockheed Martin is going to use crappy Google Docs. Never. The Chinese People's Liberation Army would steal all their trade secrets! (Power Point, Excel and OneNote are fantastic products, BTW.)

And Office is only a fraction of Microsoft's overall business. It is a well diversified company.

This is what a durable competitive advantage looks like.

In fact, Morningstar gives it's highest moat rating to Microsoft, "wide," while dolling out the middling moat rating to Apple, "narrow."

Bottom line: everyone is always talking about the risk to Microsoft. But I agree with the bond market and Morningstar. Apple faces a bigger existential risk to it's business then Microsoft. iTunes is a big powerhouse, but is also the card that can bring down the house. Microsoft doesn't have one such card.

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Notes:

1) I anticipate the old "But Windows 8 sucks!" comments. Microsoft is a big, diversified company. It earned 30 billion dollars in cash flow last year. Less then 20 companies on earth pulled that off. And the entire time peeps were crying "But Vista, but WP8 was too late, but this, and but that, OMG, the end is here!!!" Last quarter, Microsoft's sales were up 8% and it's earnings +18% (and that's after backing out the deferred revenue). While Apple had sales growth of 12% but a negative earnings decline of -18%. That's scary, especially when the core of your business is under attack by not one, but several heavyweights.

2) I am not bashing Apple. It is true, I am a fan of Microsoft. My beef is with Microsoft's negative rap. It's not entirely deserved, in my opinion.