December 2014 earnings for Microsoft (MSFT)

the report

Last night MSFT announced earnings for the December 2014 quarter, which is the second fiscal quarter of 2015 (ends in June).  At eps of $.71 a share, results were in line with analysts’ expectations, even though income was dinged by $.02  by restructuring charges and $.04 from an IRS audit adjustment.

Overall, the report was a mixed bag.

On the one hand, the restoration of MSFT to relevance under new CEO Satya Nadella continues apace.  On the other, the renewed vigor that the traditional MSFT business has been exhibiting recently appears to be coming to an end.  In particular,

–In the earnings release on the MSFT website (data are humorously difficult to download if you don’t own Office) the company made it clear that the period of extra oomph to sales of Windows caused by the termination of XP support has come to an end.  Sales had been boosted both by some former XP users upgrading to new machines and by others simply buying a newer OS.

–It’s also clear that we’re entering a period where currency effects–the decline of the euro and the yen vs. the dollar–are going to have a significant negative impact on earnings.  I think this means a drop of somewhere between 5% and 10% vs. where profits would be without currency movements.  This loss takes two forms:  a decline in the value of foreign currency-denominated assets, which is recognized immediately (in 2Q15 the figure was ($390 million); and the lower dollar value of foreign currency-denominated sales.  Part of the latter is recognized in income immediately but most sits on the balance sheet as deferred revenue before reaching the income statement (this is a long-winded way of saying that some currency losses won’t be booked for a while).  And, of course, the euro is about 8% lower today than it was on December 31st.  MSFT estimates the 3Q15 loss at 4% of revenue.

The net result of these two negatives will likely be that eps for MSFT will be flattish over the coming twelve months, rather than the +10% that most analysts appear to have been forecasting.  (How they justified these numbers in the face of the strong dollar is another issue.)

the stock

As I’m writing this, MSFT shares are down by 10%, in a market that is off by a bit less than 2%.

It’s also a day on which I’m sure lots of people didn’t make into work (and those who did are in a bad mood), as well as one where a raft of negative-surprise earnings releases have been issued.  So it’s not a good day to announce bad news.

Still, I’m personally a bit surprised by the extent of the negative reaction.  I’m not sure quite qhat to make of it, other than it’s very negative.

I have no desire to sell the MSFT I own.  On the other hand, I have no burning desire to buy more.

If I thought 2015 would be a sharply up year for stocks, I’d probably be thinking of selling to buy something with more upside potential.  But I expect the market to basically move sideways this year.  So I’ve got to be more concerned that this decline is just the first stop on a down elevator.  Right now, I don’t think that’s right, either.  But that’s where analysis has to be focused.

My biggest reaction is that I’ve got to look even more carefully through the stocks I own to uncover exposure to weak foreign currencies.  Ultimately, I guess, I believe this is the cause of the sharp MSFT price drop.

The main thing the MSFT report tells me is that Wall Street is much less far along than I would have imagined in discounting currency losses to US-based multinationals from a declining euro.  A second observation is that the European stock markets have probably been as poor at factoring in earnings gains that euro-based firms are achieving from their dollar exposure.

 

 

 

 

earnings calls: Apple (AAPL) vs. Microsoft (MSFT)

Last night after the market close, AAPL reported earnings per share that beat the consensus of Wall Street analysts–and the stock went down in the after-market.  MSFT, in contrast, reported results that fell short of analysts’ estimates–and the stock went up!

What’s going on?

AAPL gave next-quarter guidance that fell below Wall Street’s projection–but it always does this, so that’s not the reason.  MSFT’s income statement looks better after factoring out the large operating loss generated by Nokia, but I don’t think that’s the reason for the market’s positive response, either.  After all, if you wanted to (I didn’t), you could have gotten a reasonable guess at how much Nokia would subtract from the MSFT total from Nokia’s recent results as a stand-alone company.

I think the market’s response is much more a a conceptual response.

Tim Cook has made it clear that AAPL is a manufacturer of high-end mobile consumer technology.  There’s no “next big thing” on the horizon, however, with only a periodic refresh of the company’s smartphone line due any time soon.  If reports from suppliers are accurate, new offerings will include a phone with a large, Samsung Galaxy-matching screen size, and a(n even larger) tablet/phone.  For Jobs-ites, this departure from Steve’s view that phones should be small enough to operate with one hand may be earth-shaking.  But for the rest of the world, this is only catching up to what Samsung already has on the market.  So a ho-hum Wall Street response is appropriate.

For MSFT, on the other hand, the news is relatively better.  The company seems to have a focus for the first time in a long while.  The fact that Nokia is putting up operating losses at a near-$3 billion annual rate seems to me to justify the downsizing MSFT has recently announced.  The only surprise is that this wasn’t started sooner.

Leaving the X-Box content creation business is probably more symbolic than anything else, but it removes a potential distraction–especially given the continual mess the company has typically made of its game software development efforts.

One, admittedly small, figure what caught my eye was that MSFT has added another 1,000,000 individual/small business users to its Office 365 rolls during the June quarter.  I think this just shows the power of the cloud–easier administration, much lower cost-of-goods expense, and hugely better protection against counterfeiting.

For MSFT, then, the earnings were nice, but the fact that the company’s board is allowing significant changes is nicer.  True, the message may turn out only to be that the company will try harder not to shoot itself in the foot again, but even that’s an uptick.  Hence the positive market response.  Absence of missteps won’t be good enough for long, but it’s ok for now.

buying Microsoft (MSFT) !?!

Yes, that’s what I’m beginning to do.  I’ve bought a small amount and intend to add to it on weakness.

For me, this is an unusual step, since MSFT isn’t exactly what you’d call a growth stock.  Quite the opposite.  It’s a value idea.  I’ve been building to it for some time, though.  I few months ago I wrote that in a year like 2014, where I imagined (and still do) that a stock that’s up by 10% will be an outperformer, the bar is set pretty low.  And after thirteen years of decline vs. stocks in general, the news that the company had dysfunctional management and had gone ex growth had been pretty thoroughly worked into the stock price.  My son-in-law told me it’s the nicest thing he’s ever heard me say about MSFT.  (It was a big part of my portfolios all through the 1990s, however.)

I also privately scoffed at prominent value managers who loaded up on MSFT several years ago purely on the notion that the stock was cheap, ignoring the issue that change of control was well-nigh impossible.

What’s changed?   …or, better, what’s changed my mind?

As I mentioned above, the market situation is one thing.

The stock’s metrics haven’t moved much:  steady cash flow of $3+ a share, earnings of $2.75, a dividend yield of just under 3%.

There’s a chance earnings may improve over the next few years:

–the board of directors has put new top management in place.  A cadre of looks-good-in-a-suit-but-doesn’t-do-much lieutenants are disappearing, as well.  There’s no guarantee that the new guys are any better than the old.  On the other hand, it’s hard to imagine they’ll be worse.

–Apple’s failure to produce an adequate alternative to the Office suite has limited the inroads it can make into MSFT’s corporate market.

–Windows 8 (I just got a new touch-screen laptop) is pretty good–very iPad-ish.

–a new generation of Intel chips + the emergence of Samsung, Asus (my brand), Acer and Lenovo making high-quality products may well reenergize the US consumer market.  Much lighter weight, high-resolution screens, instant-on and touchscreens may counter some tablet momentum.

–with its consumer/small business products, MSFT has had a continuing (large) piracy problem.  The shift to the cloud will help police that.

–new management may do good things.  Even if not, the idea that the company is turning a new page will likely support the stock until we can make a better judgment.

Microsoft (MSFT)–a stock for 2014?

Just a thought, not a recommendation.

 

In some ways, I find it hard to believe that I’m writing this.  I’ve been mentally making fun of the value investors who have witlessly piling into MSFT over the past several years.

What’s wrong with them, I thought.  The stock is trading at 4x book value, a statistic they used to beat growth investors over the head with as an obvious indication of preposterous overvaluation.  More important, don’t they realize how weak the current management is?  …and how deeply entrenched the top is through personal friendship with founder Bill Gates?  If a decade+ of squandering corporate resources isn’t enough to force change, what would be?

Perversely, the golden goose of the Office suite has still been laying enough eggs not to impinge on the personal lifestyle of Mr. Gates, so there has been no practical reason for him to question the way his company is being run.  And Gates’ public statements show him to be very deeply committed to providing jobs for his friends.

What has changed, you ask?

Two things:

–Steve Ballmer, Bill’s now-billionaire college friend, is out.   …and the search for a successor looks to be going far beyond the ususal (for MSFT) well-dressed, glib self-marketers to  include people with actual management credentials.  So maybe change is possible, after all.

–2014 may well be an average year in terms of gains, meaning that a stock that goes up by 10% (remember, MSFT has an above average dividend, too) will probably be an outperformer.  So the bar is set pretty low.  Earnings don’t necessarily need to show any acceleration, either.  MSFT has been trading at about 2/3 of the market PE multiple for the past several years.  Just the idea that the status quo is no longer acceptable to the MSFT board may be enough to give the stock the boost it needs.

 

 

Microsoft (MSFT) and Nokia (NOK)

A few days ago, MSFT announced a $7.2 billion deal to buy Nokia’s cellphone business.  That breaks out into $5 billion for the cellphone division + $2.2 billion to license Nokia’s relevant telecom patents.

Rather joining in the chorus of MSFT-bashing that’s accompanied the deal’s announcement, I want to make a single point.  This deal has been a long time in the making–at least two years–even if MSFT may not have realized this.

In late 2010, Stephen Elop, a consultant/general manager with a tech background who had worked for almost three years at MSFT, became CEO of NOK.  He promptly issued his “Burning Platform” memo, in which he likened working in NOK’s cellphone business to being stuck on an offshore oil platform that was being consumed by fire.  Two choices:  jump into the ocean or burn to death.

He followed that up in early 2011 by declaring that NOK was opting for the briny deep by abandoning its proprietary Symbian cellphone operating system in favor of Windows.  Why not Android, which would have been the safer choice?  Differentiation, Elop’s familiarity with MSFT, the potential for support from MSFT in the form of access to its smartphone intellectual property and possibly to its enormous pile of unused cash.

Sounds a little like Ron Johnson at J C Penney, doesn’t it?   … drama, and a bet-the-farm moment.

The announcement that Symbian’s goose was cooked had the predictable result.  People around the world stopped buying Symbian phones.  Cash flow from cellphones turned from strongly positive to significantly negative.  The situation didn’t improve when the first Windows-based Lumia phones debuted later that year.

By early 2012, it seems to me, the NOK board had to begin contingency planning.  What if the Lumia phones were slow in taking off?  How much of NOK’s cash flow from its other businesses would it be willing to plow into smartphones?  How much financial support would MSFT kick in?  When would continuing to prop up a failing Lumia line threaten to pull the parent company itself under?

We now know the answers.

NOK began to negotiate the sale of its smartphone business to MSFT in February, telling us that by that point NOK had determined it couldn’t continue its aggressive Windows phone bet without putting the entire company at risk.

Why did MSFT agree to buy the NOK cellphone business?

Without a Windows smartphone, MSFT’s grand vision of creating a Windows ecosystem like Android or Apple is DOA.  Also, MSFT probably regards itself as playing with $.65 dollars.  It gets to use a (small) portion of its foreign cash without repatriating it to the US and paying corporate income tax.

Anyway, NOK’s bungling the transition from flipphone to smartphone set a chain of events into motion that resulted in its willingness to sell.  MSFT’s bungling of its decade-long mobile phone initiative made it an eager buyer.  Whether the cobmination of the two will have a happier outcome is a completely different question.