May 31, 2010

The Irregular Blather May 31, 1931

No Journal was published Sunday, May 31, 1931.

A medium-length blather on contemporary matters - an unsolicited recommendation to Steven A. Ballmer, 1 Microsoft Way, Microsoftville, WA.

As I'm sure anyone reading this has already seen by now, last week Apple passed Microsoft to become the top tech company in market cap, and second only to Exxon Mobil among US companies. This has naturally caused a ton of commentary and unsolicited advice to Steve Ballmer, prompted by the spectacular reversal of fortune between Microsoft and Apple since Ballmer took over in Jan. 2000 (in that time, Microsoft's market cap has gone from $556B to $226B, while Apple's went from $15.6B to $234B). So, again naturally, I can't resist adding my unsolicited blather to the pile.

First, an objective assessment of the debacle. As expected, Ballmer put a brave face on matters; in fact, the headline of the article above was “Ballmer Dismisses Microsoft Value Issue.” But is this entirely convincing? A quick Google search reveals that, in fact, the words “Ballmer dismisses” might almost serve as the dreaded Contrary Indicator:
Ballmer dismisses Google Android
Ballmer dismisses Apple's iPhone as hype
And, while Ballmer also argued that it's a long-term game, it must be noted that he's been CEO for over 10 years now, which is at least starting to get into the long term by most definitions.

Second, while I don't want to give stock advice here and implore you to do your own due diligence on buying any stock, in my own personal Constitutionally protected opinion it seems that Microsoft's stock is, if not Stupid Cheap, at least Pretty Darn Cheap. I mean, in the 12 months ended Mar. 31, which included part of a nasty recession, they earned $1.93/share; when you net out the $5 or so in cash and investments per share, the business is trading pretty close to a single digit multiple of earnings, which seems too cheap for a company with their financial strength and competitive position. So, while I would be the last to recommend a measure designed to pump up a stock beyond its appropriate value, it seems that taking some action to bring the stock price into a more reasonable range might benefit both Microsoft's long-suffering shareholders and Ballmer's job security and legacy.

Allow me to suggest such an action, which would almost certainly work but is so simple and non-fiendishly-complex-and-brilliant that it has almost no chance of being taken by a self-respecting tech company. What if Ballmer wrote the following letter to shareholders:

Dear faithful Microsoft owners:

Thanks for your support in this trying time. For the past few days I've been holed up with some of the world's most brilliant financial minds trying to come up with a way to reverse last week's catastrophe. And we have indeed come up with some fiendishly brilliant plans. Some involve tractor beams and sharks with frickin' lasers on their heads; others doing something with our enormous cash pile just sitting there on our balance sheet when any fiendishly brilliant financial mind knows the path to riches is to leverage that balance sheet up out the wazoo. Upon reflection, however, I've reluctantly decided to keep the existing cash pile; as we learned recently, the financial markets can sometimes freeze up and it's best to be ready for any eventuality. However, it occurs to me that the cash pile we now have is more than enough to meet any need that might reasonably arise; therefore, there's no particular point to continuing to pile up still more cash. Therefore, effective immediately and for the foreseeable future, all earnings coming in will be paid out as dividends as soon as we figure the numbers out each quarter. Thanks again for your support, and sorry about that whole Vista thing ...

If this plan had been effective over the past year, it would have paid out the aformentioned $1.93 in earnings in that time, for a yield of 7.5%, and would probably pay considerably more over the next year. While I realize Microsoft is somewhat out of favor, I still don't think there's any way it would stay at that yield for very long ...


  1. The market generally prices stock according to growth prospects.

    Microsoft gets 90% of its profits from three products: Windows, Office, and Server. That has not changed in over ten years. Microsoft has spent billions in M&A, and has tried and failed numerous times to profit from new products. They successfully bought marketshare with Xbox, and are trying to do the same with Bing, but will not break even on either for years to come, if ever. Where will growth come from? Certainly it will not materialize from Ballmer's positive attitude.

    In stark contrast, Apple has, in the past ten years, created three new products which have revolutionized their respective industries and captured the majority of the profit in each: iPod/iTunes, iPhone, and iPad. iPod and iPhone alone provide over 2/3 of Apple's profits. iPhone is still ramping up internationally, and iPad has barely begun. Their Mac business has continued to grow, and has captured a majority of profits in the laptop/desktop segment despite <10% market share. All this with R&D spending 1/6 of Microsoft's. Apple has proven its growth potential time and again, and there is tremendous headroom for future growth in each segment except iPods.

    That's why Microsoft's stock is priced to sell. For the reason outlined above, I would not call it a bargain.

  2. And here's a Motley Fool article that contends AAPL is cheap, MSFT is expensive:

  3. Hi Splashman -
    Thanks for your comments. First, let me correct an apparent misunderstanding. I in no way intended to say that Apple was a bad investment here - I agree with almost everything you say about it, so while it trades at a higher valuation than Microsoft it seems pretty reasonably priced to me. (The only minor caveats I would have are succession, and that there may not be quite as much room for growth as it seems in the desktop/laptop category - while their share of the overall market is small, their share of the market for non-cheapo units is apparently much larger - so unless Apple decides to compete in the cheapo category the ceiling may be closer than it seems). But as I said, these are relatively minor nits. I have to run now, but I will try and pick up the thread later. For now, I'll just say while Microsoft does compare unfavorably to Apple in the revolutionary new products category, pretty much every other company I can think of does also - I believe you have to look at Microsoft as a separate case.

  4. Hi again, thanks for the conversation.

    I realize you weren't saying Apple was a bad investment; I only mentioned Apple as a contrast to Microsoft's anemic growth prospects. You are correct that if Apple didn't exist, Microsoft's numbers would justifiably bedazzle Wall Street. But Apple does exist, and if Jobs' recent D8 prognostication re: "trucks" is even moderately on-target, Microsoft's growth prospects are dismal, as 90% of their profits are tied directly to the "truck" market. If, over the past ten years, Microsoft had demonstrated the ability to successfully (profitably) enter new markets, I'd be much more bullish on their stock. Absent a complete and rapid turnaround, Microsoft's growth prospects are limited to milking the "truck" market, which is comparatively saturated and may soon be in decline. Ballmer, in his D8 interview, directly contradicted Jobs' vision and essentially defended the status quo, so it seems highly unlikely that the needed turnaround is forthcoming as long as he remains at the helm. (I'll forgo the obligatory Titanic analogy.)

    Re: ceiling for Macs, you are correct that the sky is not the limit. I'm guessing you would agree, however, that with <10% share in the US and <5% share internationally, a doubling of that share is not out of the question. So while long-term Mac growth is capped, the short term is looking healthy. And I'm waiting to see whether Apple's newfound willingness to trade margin for market share (a la iPad and $99 iPhones) will spill over into their Mac business. I'm not holding my breath, though.

    Re: succession, you're right to be concerned, of course. Have you read the segment of Jobs' D8 interview in which he talks about his interaction with and dependence on his team? It was both heartening and fascinating, and my takeaway was that while Jobs is obviously very demanding (as is every great leader), he is also a great team player who has built a great team, and is less concerned with his ego than with making great products and keeping good people. But no one can know what will happen when Jobs is gone. It could be that his successor will be 80% as good as Jobs, and that might be good enough to keep Apple at the top. On the other hand, two words: John Sculley. (shiver)

  5. Just in case you haven't seen it yet, here's the Ballmer D8 video in which proclaims that the tablet is just another PC form factor upon which to run Windows:

    Apparently he hasn't noticed that in the last ten years, cumulative sales of Windows-based tablets has not equaled the first month of iPad sales.

    Ugh. Could there be a bigger contrast between the two Steves and their respective visions? Ballmer's reasoning is at times almost incoherent, and his scripted "Mac truck" wisecrack was cringe-inducing.

    In the short term (1 year), Microsoft stock is probably a good place to be. But if Ballmer stays at the top, I simply can't visualize a scenario in which their stock is above $20 in five years.