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Windows on Layaway?

Microsoft and CIT join forces to finance an intangible asset.
Rob Garver, CFO.com | US
August 21, 2006

(Correction: Changes have been made to this story, which originally ran on August 2, 2006. The changes reflect the fact that Microsoft/CIT leasing arrangement is exclusive only in France and Switzerland, not globally. CIT is expected to become a Microsoft Financing provider in other countries as part of this deal, but may or may not be exclusive provider in those countries. De Lage Landen, a subsidiary of Rabobank, currently is the sole provider of Microsoft Financing in eight countries, including the U.S. and Canada.)

When a commercial finance company loans a firm money to buy, say, new construction equipment, there is an explicit understanding that if the borrower fails to pay back the loan, the lender gets the machines. No lender really wants the title to a fleet of bulldozers, but it's better than writing off the whole amount of the loan.

But things are significantly less clear-cut when a potential borrower wants to buy a new enterprise-wide software package, or a new operating system. When all the borrower buys is the license to use a piece of intellectual property, like software, the lender has no tangible assets to claim in the event of default. By their nature, software licenses are sold by the owner of the intellectual property and can't be resold.

Last month, Microsoft announced that it had signed a five-year contract with consumer and commercial finance giant CIT Group to underwrite, fund, and manage financing arrangements for its customers in France and Switzerland. Both companies said they expect CIT to become the Microsoft Financing provider in additional countries, though Microsoft declined to say which, if any, of those arrangements would be exclusive.

De Lage Landen, a subsidiary of Rabobank, currently is the sole provider of Microsoft Financing in the U.S., Canada, the United Kingdom, Australia, Germany, Spain, the Netherlands, and Belgium. It is also in negotiations to be the Microsoft Financing partner in New Zealand.

Microsoft and CIT both said the new deal was a huge opportunity, but cited different reasons.

"If you look at the hardware market, 25 percent or more is financed or leased. In software, it's only 3 percent to 4 percent," says Brian Madison, general manager of Microsoft Finance. "It's because of the intellectual property issues — banks and commercial finance companies were hesitant to provide financing."

Madison said Microsoft has no doubt that offering financing options will grow the firm's software revenues.

"We've seen that already," he said. "One, we find that sale cycles tend to be shorter because customers don't have to go off and figure out how they are going to pay for the software. And two, transaction volumes are larger with financing."

Before entering the arrangement with CIT, Microsoft conducted a survey of all of its small and mid-market customers who had managed to secure financing for software purchases, and the findings were stark.

"One hundred percent of those customers agreed that their purchase size increased because of financing," Madison said. "On average, they said they bought 28 percent more than they would have without having the financing available."

This is no shock to Tom Hallman, vice chairman of CIT.

"Financing is a natural extension of the sales of your product — if you want to sell more, you need to offer a financing solution at the time of sale," he said. "If you have a financing solution and you can present it to the customer during the buying decision you increase the probability of making a sale."

Hallman said that CIT sees the deal as a door into an expanding market.

"There is growing demand around the world for financing programs for software, services, and warranties," he said.

But in a business climate in which customer finance arrangements have turned into millstones around the necks of finance companies — even those with tangible assets backing the loan (think about Alcatel, Motorola, and Cisco holding the worthless notes of bankrupt telephone service providers), why does CIT expect to succeed in a relatively untested lending arena?

Hallman said that even without a traditional collateral arrangement, CIT is confident that it can profitably underwrite loans to Microsoft customers.

"We have years of experience, and tens of billions of dollars of financing history to support what we do," he said.

He said CIT will make underwriting decisions based on three main factors. First, CIT's underwriters will establish the borrower's overall creditworthiness. Second, they will ensure that the software being purchased is essential to the borrower's business — an operating system, for instance. Finally, they will make certain that the system on which the new software will operate is of high quality and reliability.

"When you have those three components and you have the database that we have of how customers perform," said Hallman, "you are uniquely positioned to understand the transaction."




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