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why msft is a value trap


shalab
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MSFT has two choices - go into runoff or continue to invest in online services so it can monetize further based on the operating system sales.

 

The managements choice is clear - to invest in the ad platform. A viable ad system will help Microsoft monetize from online services. This is also the rationale for buying Skype.

 

How the investment in online services pans out is anyone guess. Primarily it is a bet on ad platform that can serve up relevant ads. It could make Microsoft a value trap as the PC mix shifts increasingly to tablets and devices.

 

Other thoughts on this welcome.

 

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No such thing as a "value trap".  Management's either make good decisions in capital allocation or they make poor decisions.  The latter results in what investors call a value trap. 

 

Fairfax could have been what we know as a value trap had Prem not made good decisions in investments, runoff and structure.  Level 3 remains what we call a value trap because of very poor decisions by management in how they allocated capital, financed their operations and viewed the economic landscape.  They are a direct result of management and not the business itself.  Even a dying business is one that can evolve based on how the remaining cash flows are redirected.  Cheers!

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Guest VAL9000

Shalab,

 

My take on this is that there are more than one potential revenue stream for Microsoft in the future.  The business lines that deserve the most attention today are Windows and Office.

 

With Windows, the operating system needs to exist on more devices.  The winning formula here combines the right features, the right application/media ecosystem and the right price.  Windows for tablet probably won't be free a la Android, but that might not matter.  Apple has proven that people will pay a premium for features and functionality.  Depending on how you slice it, the Windows revenue stream could be extended to include the revenues on related media and application sales (like Apple's iTunes), or that might be considered a different business line.  I don't know.

 

With Office, the move to the cloud could take on two different forms.  Office for consumers could be ad supported and free, as you suggest.  Or freemium.  Office for business will likely not be primarily ad supported, and instead will be a paid subscription service.  This will be priced on a per user per month basis.  Office will include the desktop applications we are familiar with, plus web-based publishing, collaboration, SharePoint and likely Exchange/Comm Server/Skype.  Extensions from there will include various other software servers.  E.g. for an additional $10/user/mo you can also have Dynamics CRM or Dynamics SL.  At least, that's my guess when I look at what the market is offering and is comfortable with.

 

When I think about advertising and Microsoft, I think that a lot of work needs to be done.  Microsoft owns a number of properties (Live, Xbox, WP7, Bing) that could benefit from a cohesive advertising strategy and a common tool set for ad management.  Google has this common tool set in place and it's done wonders for them - mostly in terms of customer self-service and cohesive advertising strategy implementation.  They manage huge ad accounts internally and the results have been incredibly beneficial to customers and to Google.  I wonder if Microsoft might consider providing the tools for ad management to third party ad agencies / ad buying groups instead of managing these customers internally.  This reminds me a little of their approach to independent software vendors and consulting services.  That is, Microsoft mostly cultivates an enormous partner ecosystem instead of actually doing software implementation work directly.  Could Microsoft implement a similar model with its advertising properties and tools?

 

I don't know enough about the advertising business to comment further.  Anyone with real experience care to comment?

 

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Hi Ben Graham,

 

I agree with you on LVLT.  My point was that LVLT was a so-called "value trap" because of management's mistakes, not because of the business itself.  This thing should have been making money hand over fist some time ago.  Cheers!

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I think part of the problem was the exorbitant amount of debt they accrued over the years, and then the ridiculous interest rates they were left paying.  Virtually half their cash flow goes to interest payments.  That's great for Prem and Fairfax, but not so good for LVLT. 

 

Then again, Prem kept them alive, so if anyone should get their share of the cash flows it should be the note holders.  But the shareholders are left with little outside of the value of the network...and that's if there is anything left after the note holders get their money back if the network was ever sold.

 

The business is great, but the management and capital allocators at LVLT, including the amazing Mr. Scott, did a pretty crappy job.  Without Fairfax, this thing would already be dead and sold to someone else.  Cheers! 

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A business in runoff mode by definition is shrinking. MSFT has kept growing FCF and maintains supernormal returns on invested capital. Everything else about what can eventually displace Windows, Office, etc and by how much should be a top concern of management, but the magnitude and outcome at this point is only conjecture - it hasn't impacted the bottom line. When and if it does, whether you have a value trap or an opportunity might be harder to determine.

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I heartily agree that MSFT isn't a value trap. As a medium to heavy duty windows pc user I can say for a fact that a tablet (have an iPad) or phone isn't going to replace my pc. I also doubt windows or office will be replaced anytime soon in the corporate market, which spills over into many homes. I use my iPad for some reading and surfing, but it's not at all suitable for my pc needs. Perhaps the younger generation of business tycoons will figure out how to manage on a tablet, but I don't think so!

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Over the past 10 years MSFT has continued to grow earnings at a pretty decent pace. Bottom line is the business has become more valuable each year. Moving forward earnings growth may slow but should still be positive. MSFT has lots of irons in the fire and looks to be positioned reasonably well to benefit from future changes.

 

The multiple (what Mr Market is willing to pay for MSFT) has compressed over the past 10 years. Probably felt like a value trap for those who bought at higher prices in 1998. Should management continue to grow earnings I have a hard time seeing how the multiple continues to compress (only possible in my mind if the whole market sells off aggresively).

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Guest VAL9000

shalab, what's your opinion of MSFT's buybacks in terms of capital allocation?  Good or bad use of cash?

 

Same question for dividends...

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"I heartily agree that MSFT isn't a value trap. As a medium to heavy duty windows pc user I can say for a fact that a tablet (have an iPad) or phone isn't going to replace my pc. I also doubt windows or office will be replaced anytime soon in the corporate market, which spills over into many homes. I use my iPad for some reading and surfing, but it's not at all suitable for my pc needs. Perhaps the younger generation of business tycoons will figure out how to manage on a tablet, but I don't think so!"

 

Well, it is often the small & incomplete new stuff that usually threatens the big mature businesses like Microsoft. Sure, the phones, iPads aren't as good as a good old PC in many occasions, but do we know for sure that they aren't going to be good enough in the future? And some collective senses are: they will completely replace PCs, for certain! Thing is, it will take time.

 

Microsoft has value and will have more in the next few years.

 

The way I see its problems:

1. crappy management with cash.

2. cancerous company culture for high tech business.

 

Unless and until these change, Microsoft will very likely grow slowly at best. Right now, this lion is sick but not old nor out.

 

 

 

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I think the selling is via automatic selling/diversification moves for Gates/Ballmer.  The reason for little buying is that MSFT is not the new thing in tech.  Tech investors would rather sell MSFT, CSCO and buy Linked-in, CRM and other crazy IPO stocks.  Once these IPOs wash up, I think MSFT will recover.

 

Packer

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The reason for little buying is that MSFT is not the new thing in tech.

 

If the insiders thought that Microsoft is a compelling value and has significant upside, they would be buying instead of selling. Even token buying hasnt happened in the last ten years.

 

How much net buying is going on at Berkshire or Leucadia?

 

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The reason for little buying is that MSFT is not the new thing in tech.

 

If the insiders thought that Microsoft is a compelling value and has significant upside, they would be buying instead of selling. Even token buying hasnt happened in the last ten years.

 

How much net buying is going on at Berkshire or Leucadia?

 

BRK at over 17x earnings and close to 20% over BV isn't nearly as cheap as some people on here are making it out to be. It's cheaper than it was a couple month ago, but I wouldn't consider it a bargain.

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The reason for little buying is that MSFT is not the new thing in tech.

 

If the insiders thought that Microsoft is a compelling value and has significant upside, they would be buying instead of selling. Even token buying hasnt happened in the last ten years.

 

How much net buying is going on at Berkshire or Leucadia?

 

BRK at over 17x earnings and close to 20% over BV isn't nearly as cheap as some people on here are making it out to be. It's cheaper than it was a couple month ago, but I wouldn't consider it a bargain.

 

Your 17x is partly the result of consolidating only the dividends of the equity holdings.

 

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The reason for little buying is that MSFT is not the new thing in tech.

 

If the insiders thought that Microsoft is a compelling value and has significant upside, they would be buying instead of selling. Even token buying hasnt happened in the last ten years.

 

How much net buying is going on at Berkshire or Leucadia?

 

BRK at over 17x earnings and close to 20% over BV isn't nearly as cheap as some people on here are making it out to be. It's cheaper than it was a couple month ago, but I wouldn't consider it a bargain.

 

So I guess the $95000 in investments / share doesn't matter? And other well-run businesses nowadays are valued under their BV?

Please explain...

 

Oh btw, based on history it is cheaper (based on price/BV, investments + 10x EPS, ...) then almost any year in the last decade, possibly the last 15-20 years.

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The reason for little buying is that MSFT is not the new thing in tech.

 

If the insiders thought that Microsoft is a compelling value and has significant upside, they would be buying instead of selling. Even token buying hasnt happened in the last ten years.

 

What about the buybacks?

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How much net buying is going on at Berkshire or Leucadia?

 

Gates was a significant buyer a few years back. I don't know about LUK though.

 

Buffett has bought no additional Berkshire shares, but said he might buy MSFT were it not for Gates being so close to him and a director (according to Buffett himself). 

 

You're getting nowhere with this insider thing.

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The presence of insider buying confirms that insider think  they will make money by buying. Absence of insider buying does not confirm that insider think it’s costly. Also, majority of time, the Insider’s selling does not tell you anything because most of the time the selling is done for various reason which has nothing to do with the valuation. Buffet and Watsa are very good capital allocator. You can not take their example and assume that other CEO's will have similar skills.

 

Yes, it will be good to have insider buying but only as additional confirmation. If MSFT seems cheap then absence of insider buying should not matter.  I don’t think moat is deep enough for 15-20 years but MSFT is not going to have their business destroyed in next 4-5 years. Last decade the Free cash flow multiple came down from 25-30 to 10. You can see the rate of share count reduction in last 4-5 years. MSFT does not need to do anything extraordinary to be a decent investment as long as they can keep doing what they have been doing for next 4-5 years.

 

There is too much noise about market share but honestly I think they will make more money in next 3-5 years. Bigger pie( developing countries …) with fractionally smaller cut will still translate to bigger profit. Business is not only cheap but very good. They should make more money so they are not value trap by long shot.  I tried to kill the thesis but I found it very difficult to kill MSFT for next 4-5 years.

 

Can you present anything which kills the thesis on MSFT? I don’t meant argument like last decade price has gone nowhere or insiders are not buying etc. I will be really interested to hear why it is not good risk adjusted place to put money at current price. How you can lose money here and also why you will not make money? Do you think we will see MSFT at 25-30% FCF yield over the next 10 years?

 

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I think you guys will do well with MSFT. The group of guys on this thread bullish on MSFT have a great track record here.

 

If it wasn t for the fact that i.MSFT is outside my circle of competence. and ii I love Mac products + find PC stuff annoying (pop ups, need for anti viral soft ware etc) I wouild be buying MSFT just on the arguments presented here. I am watching + pulling for you guys.

 

re insider buying...you cant expect W Gates with the millions shares to be buying (his shares are worth billions, buying a hundred million dollars will hardly move the needle, besides he is trying to spend the $$ on important issues). Prem + WEB diversify within the investment vehicles BRK, FFH that is why we love them so.

 

 

 

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