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Hedge Fund Managers See Microsoft as a Bargain


Parsad
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Microsoft seems retardedly cheap. Its at 7.5 - 8 x CF. The question is what will they do with that cash, I get the Ipad and Google Docs thing but if you were to put the business in run off, I think they would do just fine. The only problem is they will likely do something stupid with that cash at some point.

 

I think search and phones are both a lost cause. There moat is that old people run businesses and old people wont change.

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There moat is that old people run businesses and old people wont change.

 

and because old people run businesses, the kids they hire will have to adapt and learn to love MSFT.   :D

 

Lol I agree, this is a large cap I would love to own. I just know they will blow that cash flow.  They should put the business in run off and just acquire smart small caps. I bet they wise they had bought google when it was 10 - 20 billion. I think all of these companies are chasing the next big thing which may not come. I get the thesis on tablets, and phones but think we will always have PCs, at least for the next 20 years just due to the way corporate business is done.

 

Outside of design companies, most making over $75,000 - $100,000 have to use windows in there day to day lives and are usually too old to try anything else out. I am 27 and my MS phone just broke, and it pains me to have to figure out Android (it would take all of 2 weeks to get used to it). When I am 50 it just wont happen.

 

 

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Agree Microsoft is cheap - I think it is worth $30/share atleast given the strength of its windows/office franchises. XBox has finally turned around - looks like the new kinnect is a winner.

 

Don't think the phone is a lost cause - it seems to me that this market is nascent and it is still possible to gain share quickly. Android is a case in point. Microsoft can build a solid business around phones if its software can work with XBoX franchise well as well as do office apps well. Microsoft can also do the app model better as Android's apps will not work on all phones because of the fragmented hardware market - ala Unix.

 

Search market share - the yahoo deal is something worth watching. 30% market share is worth something - IMO. Also, Google has been forced to do catch-up with Microsoft in recent days - like image search, travel search etc. It is an uphill battle but it may turn out to be eventually cash flow positive. ( like MSN vs AOL - the dialup business was a profitable #3 in the US ).

 

cheers!

Shalab

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Agree that Microsoft hasn't spent their cash wisely. If you look at a utility vs Microsoft; Microsoft looks better - I would like Microsoft to increase its dividend so that the excess cash flow can be returned to the investors. Their G&A costs are astronomical as is the R&D/marketing cost.

 

Microsoft's biggest negative is that they got the incentive wrong - As Munger says (paraphrasing), show me the incentive and I will predict the mans behavior. In Microsoft's case, it has altered the group behavior.

 

This is also the reason I think Biglari is headed to the basement.

 

cheers!

shalab

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I have a little different opinion w.r.t. MSFT. I don't think it's a long term buy/hold stock, if that's the start, it should not be a short term stock that I have to worry about either. MSFT's products can be winners and losers, but they should not be the bases how the stock should be valued on for the long term. I don't know what people think about MSFT's business culture, but for a high tech co. that is utmost important for its survival and well being. Unfortunately, MSFT has developed a cancerous culture and that is very dangerous for its business. If the OS business doesn't change much, then at best MSFT is a run off operation. But if the OS business will change in a big way, then I don't know what MSFT will be at all. Who can say that the computer OS business will likely remain as is for a long time? I am just not sure.

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Agree that Microsoft hasn't spent their cash wisely. If you look at a utility vs Microsoft; Microsoft looks better - I would like Microsoft to increase its dividend so that the excess cash flow can be returned to the investors. Their G&A costs are astronomical as is the R&D/marketing cost.

 

Microsoft's biggest negative is that they got the incentive wrong - As Munger says (paraphrasing), show me the incentive and I will predict the mans behavior. In Microsoft's case, it has altered the group behavior.

 

This is also the reason I think Biglari is headed to the basement.

 

cheers!

shalab

 

What do you mean about incentive? Are they too focused on finding the next big thing?

 

This has been the same MS story for the last, what? 10+ years?

 

It kind of reminds me of the monarchy... they really arent that useful anymore but they can somehow hold on to their $.

 

I dont know, Microsoft has spent the last ten years earning there way out of overvaluation (aided by a share price drop). Now they are a value play but will they pay a bigger dividend and act like it. This is a sucky business strategy but they should partner on things and give up on search and phones. No real work will be done on phones for quite a while and no one is switching to bing (unless Google stumbles over privacy issues), or doing any real value added work on phones. Microsoft lost cool along time ago (minus the xbox), and is a Corporate company.

 

Open office is more of a threat then Google Docs. Every major corporation has key pieces of there finanals based on real old excel files. They wont want to put those online and probably wont want to switch over to something free. Its just not worth it. First go non profits and cheap people (schools, and me), then the masses, then finally after quite a while the corporations.

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Guest valueInv

I actually think that the new Windows 7 mobile phones are interesting and have a good chance of making a dent in the market. Mobile operators practically made Android since they needed a weapon against Apple. There is a possibility that they will do the same with Windows 7.

 

On the other hand, Windows 7 desktop has been driving revenues due to huge pent up demand for the upgrade of a 10 year old OS. This is going taper off at some point in the next two years. That part the worries me most about MSFT that they might do a huge acquisition that are unsuccessful and end up destroying a lot of value. Just a while back they were  trying to buy Yahoo. That integration would have been a nightmare. Besides, acquisitions are the flavor of the month in the industry right now. See Intel, HP, Dell, Google, Cisco, etc. The 3Par deal is just insane.

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Since 2005 the company has bought back shares and reduced total share outstanding from 10.8 billion to 8.8 billion, raised dividend to 0.52/share. Revenue and profits are still growing although at slower pace, from 32 billion in 2003 to 62 billion, net income from 10 billion to 18.7 billion, with profit margin ~30%. One thing killed the stock is the contraction of P/E ratio, from 40X in 2000 to 10 today, but I think at some point it's going to stop.

 

From technology risk point of view, I don't think MSFT is any riskier than any other tech companies. On top of Windows/Office, there are server and tools which generates as much revenue as Windows, search and online services is turning around, with the right leadership in place and with Yahoo deal they will be a credible competitor, market will support a competitor and having a choice, there is no other players who can affort this game anymore so we'll most likely end up with two main players each of them making decent profit. There are very few tech companies with such diverse set of business and deep moat. Google? really a one trick pony, the company has made no money outside of search and ads. Apple? what if they have another incident more serious than "attenna gate" and iPhone loses its lust? what if they lose Steve Jobs?  

 

The company's failure in mobile and tablet and consumer devices have overshadowed its success in other areas, but that's just a wild card. If it works out the stock would be a double, if not I would still expect 10+% annual returns.  

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Guest longinvestor

One segment which could make Microsoft oodles of money is what I'd like to call "Enterprise computing killer", what I mean is a low cost software suite which will replace the business suites such as Oracle, SAP et al. This is a baby waiting to be born. Business is so ready for it, but they are clearly locked into an endless and meaningless cycle of Oracle/SAP buys, forced upgrades running into millions upon millions with seemingly no way out. The irony is that in most businesses, most end users (managers) use these suites as simple data warehouses and use data dumps to work in the MS office environment, mainly Excel. The pricing of Oracle et al is for a lot more functionality than is used. The old adage "Price is what you pay, value is what you get" comes to mind. Microsoft stands to gain here.

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XBox has finally turned around - looks like the new kinnect is a winner.

 

 

Really?  It's the butt of all jokes on the gaming forums.

 

Perhaps, but they're boosting prices for their live service.  ($50/yr -> $60/yr)  So, it can't all be bad.

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While I think MSFT does look reasonably cheap (not stupid cheap) at the moment, I'm leary of their Win7 mobile efforts.  After the Kin debacle, the new Win7 phones need to be top shelf to compete with iPhone and Android.  From the previews I've seen, the Win7  phones look like the zune of mobile phones.

 

Good overview here:

http://www.engadget.com/2010/07/19/windows-phone-7-in-depth-preview/

 

I see a UI that is different for the sake of being different (not better) and a feature set that's uninspiring.  If not for the good connectivity to Exchange and the potential usefulness of good Office integration, I'm not sure why someone would want one over an iPhone or a good Android handset.  MSFT is in 4th or 5th place in terms of mobile; they'll need to bring their 'A' game to compete in that market.  I don't really see it yet.

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I've been thinking about MSFT as well.

 

I just fear a large acquisition...like KFT.  Yes, stock is cheap.  I think RIM is one of the few acquisitions that makes sense, and if that was the purchase, I'd be more inclined to purchase the shares.  OS on PC's and Mobile is quite a moat. 

 

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I think search and phones are both a lost cause.

 

I was just thinking about MSFT - our IT guy is very excited about the new window's 7 phones for some reason.

 

Thats interesting, have you asked him why?  I dont think they stand a chance. I know of no one who uses Windows for anything (maybe Office) because they like it. Most use it because they have to at some point and dont want to switch.

 

Apple gets people to take the time to learn how to use there products and many want to use them, same with Google. Once they start they are usually hooked, and avoid change. Phone OS is going that way. Some are hooked on Apple, some Black Berry, and some Google. BB and Apple are proprietary, and everyone else is backing Google as a way to stay viable (except for Nokia I think, but Samsung, Motorola, and HTC are).

 

I dont see where MS fits into the puzzle. I have really enjoyed my HTC Shadow and Dash for the last 3 years, but once I switch to the Android phones MSFT will have a tough time getting me back. Apple users mainly dont switch, and Corporate users are stuck with BBs for now.

 

The only advantage I have heard, is Corporations may use MSFT or Apple to avoid having to pay for a black berry server and license.

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RIMM is going to get toast in this race - their app store model has been a flop and the devices will get cheaper over time killing RIM margins. Don't see a reason for any of the players to be buying RIMM. The big three will be Apple, MSFT and GOOG as the smart phones are more tied to other features ( search, itunes, windows/office software ), the need for RIMM diminishes. Apple will be the BMW of smartphones and doesnt seem to have any inclination to produce the Ford model. GOOG will use Android to power mobile searches and  google apps. Microsoft will also use smartphone for similar reasons. It is not clear where RIMM fits in.

 

 

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I have doing some analysis of MSFT myself and wanted to check if the perceptions about Microsoft match up to the reality. I have listed some numbers and some of my conclusions from these numbers.

Some of the numbers especially before 2004 are not exact as the company has changed the segment classifications over the year. However I think they are close enough for some general conclusions.

 

i have restricted the data till 2003 as i can get the formating right. the direction of the trend is the same

 

Sales

Division performance 2003 2004 2005 2006 2007 2008 2009 2010

Windows and Windows live 10394 11546 12234 13089 14972 17211 14974 18491

Microsoft biz division 9113 10653 13520 14486 16396 18899 18910 18642

Server and tools               7192 8538 8367 9652 11175 13195 14191 14866

Online services               1953 2216 2344 2299 2474 2198 2121 2199

Entertainment and devices 2,748 2,876 3,515 4,756 6083 8459 8035 8058

Total                             33403 37833 41985 46288 53107 61970 60240 64266

Windows franchise as %total 58% 59% 61% 60% 59% 58% 56% 58%

Windows franchise growth   11.0% 14% 16% 7% 14% 15% -6% 10%

 

 

Operating margins

Division performance 2003 2004 2005 2006 2007 2008 2009 2010

Windows and Windows live 7960 8654 9442 10297 11603 12422 9982 12977

Microsoft biz division 6389 7410 9116 9620 10838 11859 11664 11776

Server and tools             1160 1418 2072 3035 3900 4149 4803 5491

Online services             -573 87 402 -74 -732 -578 -1652 -2355

Entertainment and devices -1191 -1220 -539 -1284 -1892 445 108 679

Total                             15748 18353 22498 23600 25724 30305 26914 30578

Windows franchise 91% 88% 82% 84% 87% 80% 80% 81%

 

A few points standout from the above tables pulled from the 10-K

 

The windows franchise (windows + MSoffice) has grown at a slightly lower rate as expected, but not as bad as one would expect.

The operating profit contribution from the windows franchise has come down. This is good as it means the company is now making some money from the other businesses – notably the server and tools biz.

 

Also the entertainment and devices biz (XBOX etc) is now making some money. The online services biz is losing a boat load of money mainly due to the launch of bing and other initiatives.

 

The entertainment and devices and the online service biz have complete dogs and money sucking pits for years now.

 

Income before tax 2005 2006 2007 2008 2009 2010

International 6822 6858 7199 11132 14292 15438

US 9806 11404 12902 12682 5529 9575

International as % of total 41% 38% 36% 47% 72% 62%

 

The table above shows that growth and profits are coming from the international markets which is a good sign for future growth.

 

The company can easily do 20 Bn post tax if the burn rate in the online business reduces.

 

I think the core biz of the company is still growing at a decent clip. The major growth is from the foreign markets where PCs and laptop penetration is still low and growing.

 

Key risks

I think the key risk comes more from the migration of laptops and PC to lower cost OS especially in international markets. The operating margins for such OS (windows or others) is bound to be low and will hurt the company a lot.

Also with an install base of 1 billion + for windows, I think the threat from ipads and such devices is overstated.

The other key risk is how the management will spend the huge cash, now almost 40+ bn. The past capital allocation decision beyond the windows franchise have been very poor. A buyback and dividend plan will reduce the damage the management can do.

 

Would welcome counterpoints to my arguments

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XBox has finally turned around - looks like the new kinnect is a winner.

 

 

Really?  It's the butt of all jokes on the gaming forums.

 

Perhaps, but they're boosting prices for their live service.  ($50/yr -> $60/yr)  So, it can't all be bad.

 

Yeah, I've read about it.  I've been sensing a huge backlash from the Xbox community. 

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Rohitc99 - I like your analysis. Despite the iPad, Windows still owns 94% of the market share. Apple has the first mover advantage but unless it can move to the lower end, I dont see it displacing Microsoft. It will be interesting to see if we will see a windows version of the tablet - I think we will in the near future.

 

The biggest risk with Microsoft is capital allocation ( or lack there of ) by management.

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Would welcome counterpoints to my arguments

 

I am an accountant, but I rarely spend so much time analyzing companies in such detail (that can hurt sometimes such as with KSP).

 

You can typically boil things down to 2 - 3 points that will determine where things go.

 

The points I think are important is how will MSFT deal with the change in landscape (Search, Phones, and Challenges to OS). I think the stock is cheap for these issues and these issues are largely overblown.

 

The next big point and most important one to me is what will MSFT do with the cash. If you had unlimited wealth you could buy MSFT and have the entire basis paid off in 7 years or so, probably less if you cut R&D. Anything after that would be a return. I think the OS business dominance will last another 10 years at least making MSFT a good deal.

 

The issue is - will they reinvest that cash wisely, dividend it out, or blow it on stupid pointless things. My guess is 1 or 3. Tech companies dont like 2. If get comfortable with how they use their cash then its a no brainier. I am not so comfortable at this point. I think they will use the cash to pursue the fade of the day - Search, Social Networking, and Phones. I think its tough to pick winners in those spaces, and would prefer not to.

 

 

 

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