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Viking
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I established an initial position in MSFT today. I think it has become a very boring stock...

Price = $26.00

2010 Earnings = $2.05 to $2.10 (lets say $2.07); PE = 12.5

2011 Earnings = $2.20 (could easily come in higher should the economy continue to stabilize)

Dividend = $0.52 = 2%

Cash on hand = $5.00 per share; No debt to speak of. With earnings buying back meaningful amounts of shares and I would expect the dividend to continue to increase.

Can$ = $0.95 (relatively high, which is important for a Canadian investor)

Shares were trading at $31.38 in April; down almost 18% in a month.

 

Here are a few more good points from controlledgreed.com:

April 19, 2010 More on Microsoft from Fred Hickey in Barron's

Microsoft (MSFT) is a major holding in my portfolio. So Alan Abelson's column in Barron's (scroll down) caught my eye when he wrote about Fred Hickey (of The High-Tech Strategist newsletter) and Hickey's continuing bullish view of the company:

 

Not only has the company's Widows 7 proved a big winner (in contrast to its predecessor, Vista, which was a disappointment for sure and even a borderline bust), but Fred has high hopes for the new operating system that he confidently expects to enjoy a wave of demand from business buyers. He also believes the upgrade of what he calls Microsoft's other cash cow, Office, shipments of which are slated to start in June, will meet a warm reception.

 

Moreover, he is quite enthusiastic about relatively recent and promising new additions to the product line, like the SharePoint server, Bing search engine and Microsoft's "Project Natal" for the Xbox 360 game console, scheduled for unveiling June 13.

 

He contends that the stock (ticker: MSFT) is still something of a steal at 16 times depressed trailing earnings. Fiscal third-quarter profits, you might take note, are due to be released Thursday.

 

As Fred points out, Microsoft's software is firmly entrenched in most large business enterprises and its sundry software offerings are "complex and interoperable," while Google's comparable products just aren't in the same league.

 

"In this overpriced, dangerous stock market," he says, "I regard Microsoft as a great gift." Despite his usual aversion to hyperbole, he calls it "the most valuable tech stock in the universe." And, he waxes on, "Microsoft generates huge cash flows, pays a nearly 2% dividend, has a stock price upside of, say, 50% if the bull market continues to run, and limited downside if it does not."

 

I agree this is an overpriced and dangerous market. But an upside for MSFT of 50%? I don't know about that, yet would love to see it come about.

 

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I also started a position in MSFT this week. The weird thing is that I could not find a reasonable explanation of why its price decreased so much the past few weeks. It went below $25 on Wednesday and rose back to $26 today and I could not understand why we had such a swing...

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Hi Eric,

 

It was because the European Union fined them $1.35B.

 

http://news.cnet.com/8301-10784_3-9880256-7.html

 

We were close to starting a position, but just not quite cheap enough yesterday.  You guys are correct, about it becoming a cheap, boring stock.  Alot of premium companies are cheap, boring stocks right now...especially compared to many of the small and mid-cap stocks.  Many have been in a bear market for a decade now, as their earnings and cash flows have finally caught up with their valuations.  They may continue to be discounted a little longer.  Cheers!

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I am not sure about MSFT for the mid to long term. I tend to think that MSFT has run its course in the technology field as the Sun in a day. Its main problem comes from inside and it has been this way for a few years now. Its culture has deteriorated to such a point that even a new CEO may not be able to right it. It won't die by all means for many many years, but it will suffer in all aspects from any and all competitors because MSFT is no longer competitive. More importantly, its PC OS business (one of its main revenue pillars) will go way down almost for sure due to the fact that this time around APPL does everything about right. Mobile phone business is basically over for MSFT. Office business is still strong and will remain that way for a while, but it can't make up the revenue loss by the OS business. Search will continue to be an underdog for a long time, it won't make enough money to change the fate of the company. Game business is coming strong, but it will suffer similar fate as the OS business because they are in the same boat more or less. Once it becomes obvious that APPL and the likes are taking MSFT's lunches and dinners, it will reflect even more in the revenue and stock prices. But I am not worried about MSFT in the short term, like within a year or two.  

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I was hoping it would fall below $20 again.    ;D  How much cash do you think is excess for the company?  MSFT is reporting about $40 billion in cash during the most recent quarter.  My estimate is it only needs about $10 billion, the other $30 billion in excess.

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Sanj, I think your article is from 2008. The stock dropped $1.00 yesterday because Steve Ballmer expressed concerns about lack of property rights protections in China and suggested Microsoft may need to shift some production to India (I think). The stock went up $1.00 today due to 4 different brokerages reiterating their buy rating on the stock (which made me think a little as I normally am not on the same page as analysts).

 

20ppy, I think you very nicely summarized what the stock trades at a PE = 12.5 despite what look to be pretty good financial picture and near term outlook.

 

MVP, the growing cash hoard also has me mystified. Does anyone know what they are going to do with the $40 billion in cash (and growing)? Yes, they are buying back stock and, yes, I would expect they will increase the dividend. But even after that they will still be growing their total cash holdings. Given the strong link to Buffett I would hope they do not blow it on a bad aquisition...   

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    No doubt the value metrics and the unmatched franchise make MSFT appear quite attractive.  The hang-up for me is that management has never appeared to have the maximization of value per share as their number one priority.  Ballmer's stake alone is over $10bln so one can hardly blame him for being affected by the law of diminishing marginal utility.  It's unclear to me what the answer would be if Ballmer were to have to choose between a)  20% share price increase, but smaller company size, or b) 20% company size growth with no increase in share price.  When possible I'd much prefer an investment in a company with an owner/operator who has a $20mm stake looking to grow it to $40mm.

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Let us compare MSFT and WMT. MSFT is not a value yet for me because:

 

1. MSFT is losing mind share which eventually will lead to market share erosion.

        The windows and office franchise are in a secular decline which will take several years to play out

 

  In recent years, Microsoft has lost the browser market share ( from 90%+ to around 50% and declining ). Windows market share is also declining although slowly. The pricing of both windows and office franchises are under pressure because of free alternatives. Increasingly MSFT is forced to operate expensive data centers and offer the services free.

 

  WMT is expanding internationally and its cash flows are good and more predictable than Microsofts.

 

2. MSFT cash flow after backing out dividends is lower than that of Google and Apple.

        It is not going to be easy to displace the other two tech goliaths. These tech companies can reinvest as aggressively or better than Microsoft and enter new markets.

 

    WMT cash flow is sustainable and is not likely to erode.

 

3. Tech tends to have winner take all model

      This was a blessing and increasingly a curse to Microsoft. Look at search

 

4. Management has a poor track record of reinvesting capital

      At some point Microsoft will be a value stock, it isn't yet.

 

5. Poor second tier management

      After Gates and Ballmer, there isnt a good replacement in place to look at the variety of businesses at Microsoft.

 

 

 

 

 

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Sanjeev - you had me. I was thinking: "but this is old news...". Having said that, the 4% swing that we had the past 2 days is high for a period with no real material news. I think it's just the markets that are nervous. Hopefully, it will go down more in the near future and provide an even better entry point.

 

Shalab - I disagree with your first point:

 

I think Windows 7 has a lot of momentum. The numbers I have seen are very compelling. For example, Dimensional Research polled a large sample of IT professionals a couple of months ago and 87% responded that they planned to migrate to Windows 7. Just yesterday I had lunch with a friend who works for a large Fortune 500 firm and he confirmed that all new PCs are now systemically coming with Windows 7.

 

I think the upgrade cycle is just starting to kick in. And there is a huge pipeline of new products that are just being released: Office 2010, Sharepoint 2010, a new version of Digital studios, etc. HP mentioned in its recent earnings call that the PC sales had lots of momentum.

 

Vista was a disaster and Windows 7 is what Vista should have been. But the moat surrounding Windows and Office is still deep and with lots of sharks.

 

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Sanjeev,

 

I agree with you that big high quality caps are now getting cheap. It struck me for a while and I am looking very seriously at names like MSFT, KFT, JNJ etc... (I have even been trading in and out of some for some time). However, many of them are quite exposed to the entire world and I am very worried about what's going in on the world - Japan, Europe in particular, more optimistic about emerging areas (new customers but lots of volatility). How do you discount these risks in your valuations ?

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I look at it this way -- where is most of the innovation happening in the computer hardware and software world?  I would say companies like Apple and Google with products like the iPod and iPad (also the Kindle), mobile devices such as Blackberry, Droid, etc., digital media such as iTunes and iBooks, and the vast array of services at Google such as maps, mail, AdWords, etc., social media such as FaceBook, YouTube, etc.

 

What is Microsoft's participation in these markets?  Minimal, in almost all cases (Bing might be a standout counter-example).  They are getting flanked in a major way by other companies who are defining the new ways of using computers and software while Microsoft dominates mature but increasingly irrelevant markets.

 

Microsoft is headed towards dinosaur status unless they can start to innovate and create new products that people want, something they haven't done in over 10 years, if ever.  IBM rose from the tar pits by reinventing itself as a services and finance business, Microsoft would have to go through a similar kind of transformation in order to succeed long term IMHO, but I don't think that is likely.

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Just yesterday I had lunch with a friend who works for a large Fortune 500 firm and he confirmed that all new PCs are now systemically coming with Windows 7.

 

yeah, this choice is a no-brainer for companies. No one in their right mind is selecting Vista when they can have Win7.  It would be like buying Windows ME after XP came out. Win7 performs better than Vista even on underpowered netbooks.

 

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I wouldn't be surprised if Microsoft uses it's cash to make a bid for RIMM at some point.

 

I think both Microsoft and RIMM currently make products that are inferoir to companies like Apple and Google, but Microsoft still dominiates the enterprise market. Blackberry has a pretty strong grasp on the mobile business market, and if Microsoft still struggles with it's mobile devices after they release Mobile 7, buying RIMM would make some sense. I'm not saying I think that would be smart of them (I think Blackberry's are currently years behind the iPhone and Android in terms of innovation), but it wouldn't surprise me.

 

MSFT stock is a pretty good value for the consistent $ they make, but they do not have the long-term growth, and their lack of innovation over the last decade or so is pretty pathetic. They've gone into 'copycat mode', where companies like Apple and Google release innovative products, than a couple years later Microsoft produces an inferior copy (just as those other companies are already moving on to new things).

 

I wonder if Gates will ever feel the need/desire to rejoin the company, a la Steve Jobs after he left Apple.

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Guest misterstockwell

They definitely dominate gaming. If you have anything other than Xbox 360, you are a major loser. They continue to innovate there, and grab greater market share. With upcoming evolutions, that will ony get better. Now that cable cards can be installed in any PC with the compatible tuner, you will see much more out of Windows Media Center. Once you use Media Center, you would toss your cable set top boxes out the window. The integration with Zune and the Xbox is far beyond anything Apple has done, much more friendly, and doesn't have a toll like Apple adds to everything. Our household is Apple-free, and I love it. I am also a huge fan of Windows Home Server for automatically backing up everything in the house.

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Well the XBox is #3 in market share after the PS3 and Wii, so I wouldn't exactly call all of those PS3 and Wii owners losers.  MSFT is again getting beat in the market everywhere that they can't leverage their desktop monopoly.  The EDD division of MSFT (which produces the XBox) also fails to make money, aggregate earnings over the last 3 years is a loss of $1.2 billion.

 

Look at the segment results from MSFT and it is kind of surprising.  Online services have also lost money for years.  The earnings come primarily from business services, server, and client software, but these segments do not show growth.

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Total 2009 US console sales, Xbox 4.77 million, PS3 4.33 million. The Wii is a toy. If you are a gamer, you have an Xbox, and you pay your yearly Xbox Live fee. Your PS3 plays BluRays. Your young kids play with a Wii for a few months and its mothballed. If you have teenagers, you know what I mean about Xbox.

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Well the XBox is #3 in market share after the PS3 and Wii...

 

I think Xbox 360 > PS3 in market share.. someone corrects me if I am wrong.  I think the amazing thing about xbox is it emerged from a nobody to a significant player.  When the original xbox was released, I was thinking "what's msft doing? how could it possibly compete with PS2?" And now the xbox business is profitable.

 

 

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Guest misterstockwell

Well the XBox is #3 in market share after the PS3 and Wii...

 

I think Xbox 360 > PS3 in market share.. someone corrects me if I am wrong.  I think the amazing thing about xbox is it emerged from a nobody to a significant player.  When the original xbox was released, I was thinking "what's msft doing? how could it possibly compete with PS2?" And now the xbox business is profitable.

 

 

 

"In March 2010, the three manufacturers crossed the mark of a combined 60 million consoles sold. Microsoft sold 19.7 million Xbox 360s in 53 months (an average of 372,150 units per month), Nintendo 29.0 million Wiis in 40 months (724,667 units per month) and Sony 12.1 million PS3 in 40 months (301,825 units per month). Since November 2006, when the PS3 and Wii were launched, Nintendo leads the market with an overall share of 47.7%, followed by Microsoft with 32.45% and Sony with 19.86%."

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I was a buyer of MSFT at $18 (last year).  The price was so low that I thought the Windows + Office businesses alone would be worth the EV.  Their server business is quite valuable too although I didn't even attempt to value it.  All the Bing / Mobile / zune / funny businesses are just noise (or options if you want to call them that).

 

Windows & Office are not going away anytime soon, especially in the corporate setting.  The argument is related to compatibility.  For example, however google doc / staroffice / etc improve, there's no way they will replace *100%* of the functions of Office.  For a corporate user, there will always be at least 1 or 2 features that he can't find it on a competing software and this would deter the organization from switching.  99.999% similarity is not sufficient -- simple network effect.  And then of course, no one wants to send his client a file that may not be 100% compatible, whether that's a perceived or real risk.

 

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Shalab - I disagree with your first point:

 

I think Windows 7 has a lot of momentum. The numbers I have seen are very compelling. For example, Dimensional Research polled a large sample of IT professionals a couple of months ago and 87% responded that they planned to migrate to Windows 7. Just yesterday I had lunch with a friend who works for a large Fortune 500 firm and he confirmed that all new PCs are now systemically coming with Windows 7.

 

Win7 may have short term momentum but then why I should I buy the next OS? The only reason is new hardware or I got hardware for vista which is not usable. There is even less reason to upgrade to newer Office.

 

There is no question that Windows market share (laptop + desktop) is declining though slowly.

 

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I think Windows 7 has a lot of momentum. The numbers I have seen are very compelling. For example, Dimensional Research polled a large sample of IT professionals a couple of months ago and 87% responded that they planned to migrate to Windows 7. Just yesterday I had lunch with a friend who works for a large Fortune 500 firm and he confirmed that all new PCs are now systemically coming with Windows 7.

 

I think the upgrade cycle is just starting to kick in. And there is a huge pipeline of new products that are just being released: Office 2010, Sharepoint 2010, a new version of Digital studios, etc. HP mentioned in its recent earnings call that the PC sales had lots of momentum.

 

I think your friend's comments are only valid up to the (less mobile) WiFi standard.  MSFT's OS is dominant in this segment.  But as you shift toward 3G (and beyond) -- the windows mobile position is pretty weak.  Higher portability will take away market share from less portability and this will gain significant momentum as 4G rolls out.  In the 3G+ portable segment, RIMM and Apple are the leading players in North America - but Android is rapidly catching up (with Windows falling behind considerably).   As most device makers (excluding RIMM and Apple obviously) shift toward the more mobile segment, the trend is toward the open Android OS.  A recent exception would be HP's recent purchase of Palm (for it's Web OS).  I agree with Tiddman's comment that perhaps a takeover of RIMM could be in the cards for MSFT -- but that is not without it's challenges either. The flip-side to this could be RIMM adopting the open Android platform.  

 

Bottom line is cell/smart phone device makers and computer manufacturers are converging into each other's space - with an explosion of variety and choice.  Apple makes some great products, but if you look beyond the current hype -- toward the variety and choice that is coming and the tremendous innovation taking place, it's heavily geared toward the open Android platform.  Not only does Android have Google's full support and lead --- it is also the reason behind the founding of the Open Handset Alliance which continues to add some very significant members:

http://en.wikipedia.org/wiki/Open_Handset_Alliance

http://www.openhandsetalliance.com/

 

What a handset means to us 5 years from now will take on more meaning than it does today.  Again as this innovation takes place, portability will be a key market share driver.  This is what MSFT must adapt to -- the hurdle they face (more than Apple or anything else) -- is this 'open' movement.  

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The story is best told through operating margin.

 

MSFT's operating margin has declined from 51% in 2001 to 39% in 2009. My belief is that this is a secular downward turn that won't go away soon without putting the windows/office groups in run-off mode. I expect windows/office to last for a long time - probably our lifetimes but they won't have the cachet they had once.

 

AAPL on the other hand is expanding margins. It went from a loss in 2001 to 23% operating margin in 2009. Not sure how much they can trend up here - they have done well in the US gaining almost 10% of the desktop/laptop market share but in rest of the world, it hasn't caught up yet. You can see as having more upside than downside.

 

cheers!

 

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