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.

 

 

measuring Steve Ballmer

On the day before Steve Ballmer took over as head of MSFT, that company’s market capitalization was a tad below $600 billion.  If MSFT shares had matched the performance of the S&P 500 since then (about +15%), the company’s stock market value would now be just  under $700 billion.  Instead, just before the stock spiked on news of Ballmer’s surprise resignation, MSFT was worth barely a third of that figure.  Under his stewardship, then, MSFT owners lost a staggering $450 billion in relative stock market performance.

Sometimes the simplest measuring sticks are the best.

(Yes, MSFT management has bought back about 20% of the outstanding shares since 2006, but it’s hard to know what the net effect of the stock purchases would be.  Certainly, earnings per share would be lower.  Arguably, the stock price would be, as well.)

In late 1999, I sold the MSFT shares I had held for a decade.  The price earnings multiple was crazy high and it was clear that MSFT has no internet strategy.  But for a while I kept going to the annual analyst meetings in Seattle.

At one of them, Mssrs. Ballmer and Gates were jointly hosting a Q&A session.  One analyst raised his hand and observed that the annual earnings growth rate of Microsoft had dropped from 20%+ to mid-single digits.  He asked when management thought the company would resume its former rate of growth.

Awkward   …especially in a public forum.

I don’t think the questioner had any ill will, though.  He just wasn’t a particularly vivid-color crayon.

The response was illuminating.

Gates and Ballmer were both very harsh.  They all but called the guy an idiot, and asserted that it was a triumph of management to achieve any earnings growth in a firm of MSFT’s large size.  Wow!

What did I take from this?  Three things:

–neither Gates nor Ballmer was a very nice person,

–working for them it would be their way or the highway, and

–MSFT wasn’t going to have huge earnings growth because neither of the top people thought it was possible.   (The fact they subsequently brought in the head of a forest products company, a mature, cyclical commodity industry, to cut costs as CFO says it all.)

For the record, I thought Steve Ballmer was a bad CEO.   Not Carly Fiorina bad, but pretty terrible.

On the other hand, Bill Gates selected Ballmer and kept him as CEO for more than a decade.  So until very recently, he clearly approved of what Ballmer was doing.

If we want to lay blame at anyone’s door for MSFT’s weak performance during Ballmer’s tenure, the lion’s share would be delivered to the front of the Gates compound.

thinking about tablets–and ecosystems

my tablet

I’ve owned a iPad for several months.  I use it much more than I expected.  I’d use it even more than I do, but the AAPL “walled garden” prevents me.

My only real complaint is that the wi-fi chips AAPL uses in its tablets appear to be relatively weak, so mine (a “new” iPad) often wants to make a cellular connection.  My wife’s (an iPad 2) has the same problem.  Here on my back porch, my Macbook hooks up to our wi-fi without a problem; my iPad can’t make a connection.  Design defect  …or concession to the mobile network operators?

One more thing–I’ve spent much too much time playing Kingdom Rush.

in the schools

The iPad has picked up momentum in areas I hadn’t really thought about.  For instance:

–AAPL commented in its 3Q12 earnings call that it is beginning to sell a ton of iPads to schools.  They’re all iPad 2s, which apparently have hit a price point low enough to trigger mass orders.

–an interesting article in the Financial Times from late July outlines changes tablets are making in the scientific/medical press.  It’s short and worth reading.

professional journals

Its message is that there is a surprisingly quick transition to online delivery going on with professional journals.   For doctors’ publications, the positive points of online are:

-most physicians have and use tablets, especially for reading between patient appointments;

-doctors read close to double the amount of a journal’s content when they access it online rather than in print;

-they appear happy to watch video advertisements imbedded in the online articles; and

-the publisher has precise data to show advertisers about what online ads have been seen.  For print, the publisher has to rely on surveying users–and who’s going to say he doesn’t read the journal from cover to cover?

Googling “tablets and medical journals”

My results were mostly about the perils of sleeping pills.  But I did come across a medical student’s blog post on the merits of various tablets.   Steven Chan’s conclusions are about what you’d expect, with one exception:

–using a tablet is a lot better than carrying files around with you

–if you’re hopeless with tech, get an iPad.  It’s easy to use, but limited by the AAPL “walled garden”

–Android tablets are harder to get up and running but are much more useful

–the iPad is too big to fit into a standard white lab coat pocket.  If you use an iPad you should get a new iPad-friendly model (this is the one I didn’t think about).

my investment point?

It’s about ecosystems.   In a world of cloud storage, where individuals own multiple devices–smartphones, tablets, laptops–that they may want to function for both personal and work tasks, the choice of what products to use becomes less about how cool the individual device is and more about how the device allows one to access, share and save data.

Yes, everyone believes this, to one degree or another.  In a “cloud” world, though, AAPL has two (well-known) weaknesses, I think.  One is its “walled garden” approach, which makes it seem a little like AOL when the WorldWide Web was opening up in the 1990s.  The other is how weak AAPL’s browser and productivity software are.

Again, no secrets here.

What’s interesting, though, is how this leaves the door open for MSFT, even after more than a decade of bungling, to become relevant again.  It has an adequate browser, which seems to be losing its my-way-or-the-highway attitude.  Its productivity suite is the world standard.  More than that, MSFT seems to me to understand the new opportunity its position is giving it, and (for once) to be taking intelligent steps to exploit it.

Anyway, I’m starting to think I may have to take MSFT more seriously as a potential investment, for the first time this century.  If I only thought MSFT had good management…

how cheap is MSFT? …very

MSFT…

When I was writing about AAPL yesterday and wanted to make the point that the stock is cheap, I looked around at other, much weaker, tech-related firms to see their valuations.  I wanted to illustrate that AAPL shares are not only cheap in an absolute sense but are also inexpensive relative to other tech firms with weaker managements and/or inferior business models.  I settled on CSCO as a good example of both latter characteristics.  There were lots of others, too.

…is a very cheap stock

While I was searching, I took a quick look at MSFT.  I knew it has been the darling of value investors for some time.  But I was stunned by how cheap it is–much cheaper than AAPL.

I do have some history with MSFT.  I’ve been a user of its products beginning with the 30 lb+ Compaq “portables” of the early 1980s.  I bought the stock in my portfolios for the first time in late 1990.  I held it continuously for almost a decade, before selling it in late 1999 at around double the current quote.  Yes, I have subsequently held the stock for short periods after that, at the urging of a former CIO, but without much conviction–and without much success.

details

But this is what I saw yesterday:

1.  As of June 30, 2012, MSFT had cash of $63 billion.  Against that, the company had $11 billion in debt.  So net cash is $52 billion.  8.4 billion shares are outstanding, meaning net cash amounts to $6.20 per share.

2.  During the June 2012 fiscal year, MSFT generated $31.6 billion in cash flow, or $3.75 a share.  It spent $2.3 billion of that on capital equipment and about $10 billion more on dividends and stock buybacks.

3.  Consensus Wall Street estimates are for about a 10% increase in cash generation over the coming year.

some arithmetic

The share price of MSFT as I’m writing this is about $29.  Subtract out $6.25 in cash, leaving $22.75.  Dividing by $3.75 indicates that MSFT is trading at about 6x cash flow in fiscal 2012 and 5.5x expected cash flow for the coming 12 months.  That’s an extremely low number, especially for a firm like MSFT which has negligible capital spending needs.

Why so cheap?

What is this valuation saying about the company?

Three possibilities:

–much of MSFT’s cash pile, and a good portion of its profits, are accumulating overseas, free of US corporate tax.  Returning that money to the US, where it could be used for dividends, would require that MSFT pay Uncle Sam.  To some degree, that lessens the value of MSFT’s cash flow.  But any global company is in the same boat.  And, although think it’s an issue, Wall Street doesn’t seem to mind at all.

–top management has been, well, bad, for at least a decade.  These are the same folks who wanted to pay $40 billion+ for YHOO a few years ago (they probably thank Jerry Yang every day for refusing to sell).  They just took a $6 billion+ charge for impairment of goodwill–acknowledging that the company overpaid substantially when it bought aQuantive five years ago.

On the other hand, MSFT has the dominant PC operating system.  And neither AAPL nor GOOG, nor Linux have been able to make much headway against the Office productivity suite.  So they have arguably been adequate stewards of the MSFT legacy of the last century.

In addition, poor management is often a plus for value investors eyeing a stock.  They imagine how much better things could be if competent hands were at the tiller.

–Is change of control possible?  It’s hard to say.  My impression is that MSFT has always been run for by long-time friends of Mr. Gates, whom he knows personally and trusts.  He seems extremely loyal to managers he has appointed, without much regard to their objective performance.  As the past decade+ has shown, change from within doesn’t appear to be a good bet.

Forced change from the outside?  Together, the founder and Steve Ballmer, the CEO, own 10% of MSFT.  The Bill and Melissa Gates Foundation may own more.

History shows that individual shareholders are immensely supportive of incumbent management, no matter how bad its performance may have been.  A proxy fight involving a company this large would be expensive. Its outcome would be hard to predict.  Are individual investors going to  support a movement that will effectively unseat Mr. Gates?  I’m not sure.

I think the belief that corporate change is unlikely is the main barrier to a better valuation for MSFT.  Wall Street believes–with ample justification, I think–that a dollar of cash flow in the hands of MSFT management is worth substantially less than one hundred cents.  And the market believes there’s no easy way to change the situation.  That’s certainly what I hear the stock price saying.

 

 

 

MSFT is making its own tablet …why?

the Surface tablet

Two days ago, in Los Angeles of all places, MSFT unveiled its new Surface tablet.  You can see pictures and get specifications at the company’s still-under-construction Surface website.

The tablet, slightly more oblong than the iPad but otherwise quite similar, will be available through MSFT’s bricks-and -mortar stores, as well as online.  There will be two versions, one driven by an ARM chip and a heavier-duty one driven by an INTC processor.

Although details are scanty, debut appears to be set for at least the lighter model late this year.

plusses vs. the iPad

There are some.  For instance,

–the iPad comes with a watered-down version of the Safari browser.  Ugh.  Surface will presumably let you use Chrome.

–there’s no easy way to type on an iPad.  I’m using the latest Logitech keyboard/cover on mine.  But even though reviewers say it’s the best yet, it’s still pretty clunky.  Surface has a lightweight keyboard/cover.

Of course, you can use the dictation feature on the iPad.  But try that in a library or on the train.

–you can’t create an Office document on an iPad, either.  Surface will come with special editions of Office, although whether the software will be available on Day 1 isn’t clear.

why have a Windows tablet?

Tablets are a great form factor–something MSFT knew when it pioneered the tablet almost a decade ago.  The company’s versions were just too big and clunky to be successful.

Thanks to AAPL, corporations now want to use tablets.  So do schools and colleges.  But the fact you can’t create usable documents or spreadsheets is a big drawback.  The longer this situation exists, the more pressure there is for tablet fans to create a non-MSFT solution to their productivity needs.

So the lack of a viable MSFT tablet is a continuing threat to one of MSFT’s core businesses.

why make one?

The first thing that comes to mind is that MSFT doesn’t think much of the tablet offerings by HPQ, DELL or their Asian competitors. That’s probably right.  You don’t see people camping out in front of Best Buy to be the first to own their latest models.

However, look at INTC.  To get the Ultrabook going, INTC created reference designs for the new product it wanted.  It gave the Ultrabook blueprints to manufacturers for free and promised them a lot of advertising support for any products that met its specifications.  Why didn’t MSFT follow suit?

Also, unlike the case with the X-box, manufacturing a tablet puts MSFT in direct competition with its main customers, the PC makers.  That can’t make the latter happy.

And, although MSFT has doubtless learned some tricks over the years, the company doesn’t have a stellar reputation as a device maker.  Think: the initial X-box or the Zune.

So why, then?

I think it’s to control the pricing.

Because of its high production volume, AAPL has a significant cost advantage over any maker of a competing tablet.  In addition, MSFT will likely have to price its offering at a discount to AAPL to induce buyers to give up the “cool” factor of the iPad and the convenience of the App Store.  There’s no room for a competitor to make much (read: any) money on a tablet, if it’s got to be better than the iPad and be priced lower.

In fact, my guess is that MSFT would count itself extremely fortunate to break even on the Surface in the first couple of years.  I think the company would sign on the dotted line in an instant if someone could guarantee MSFT would sell 10 million Surfaces in the first year, provided it priced the tablet at a $100/unit loss.

MSFT has done this before.  My view of Surface isn’t that far off from MSFT’s experience with the first-generation X-box.  Remember, too, that MSFT generates $1 billion in cash flow in less than two weeks.  Chump change isn’t an expression often linked to $1 billion, but it conveys the idea.

save me a Surface (the INTC one)

I’m not a particular MSFT fan.  But a successful tablet removes a perceived threat to MSFT’s core Office business, it makes the company more valuable.  In that sense, Surface is a potential big plus.  Personally, I’d prefer to buy a Surface when they come out.