Microsoft Shares – What To Make Of All The Negative Noise?
Is now the time for investors to bail – or stay – out?
We put the question ‘Is Microsoft (NASDAQ:MSFT) losing the plot?’ into Google’s search engine and every one of the 10 items on the first page of results was on point. Indeed, it was only at the bottom of the second page that the results went off-topic – to a blog item on whether Apple (NASDAQ:AAPL) was losing the plot.
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We then used that exact same question in Bing – Microsoft’s would-be-if-it-could-be rival to the Google (NASDAQ:GOOG) search engine– and not a single entry on the first page addressed the search terms. Indeed there was only one entry about Microsoft at all on that page, a blog asking ‘Is Microsoft winning or losing the war for developers?’ There were several entries helpfully explaining the meaning of ‘losing the plot’ but the search result conveyed the distinct impression that if Bing had understood the question posed by our search terms, it wasn’t about to provide any answers.
In fact though, as the Google search demonstrated, over the past several years a sizeable slug of the tech-focused blogosphere has been devoted to the proposition that Microsoft has run out of ideas, has become moribund, a cash-cow locked into a product range which while still generating billions has a use-by date, and is – in a nut-shell – losing the plot. The company’s ‘lost decade’ at the start of the current century is held up in evidence.
But still a swag of cash – and unbelievable performance over the years
Of course, no-one is suggesting that Microsoft is a candidate for Chapter 11 any time soon. Amongst other relevant stats, as of 30 June this year the company had $77 billion in the bank, in cash and cash equivalents, up 22 percent on a year earlier. Shareholders’ equity at nearly $79 billion was almost double that at the close of the 2009 financial year.
And speaking of equity, a tool on the Microsoft website allows visitors to see what a given investment in the company’s stock at any given point in time is worth today. The default setting is for 100 Microsoft shares purchased in the float, way back on 13 March 1986, at $28 per share (the listing price was $21 but the stock was bid up to $28 within hours of the opening). Based on today’s share price, after the bonus issues and stock splits and assuming dividend plough-back, those 100 shares have become 40,130 and the $2,800 outlay is now worth $1,516,130.99 – a return of 54,047 percent. That’s pretty cool, as Microsoft might once have said.
The miracle of Windows 95
In 1986, Microsoft was already a major player in software – as its spectacular float bore witness – but the golden years still lay ahead. If ever there’s been a licence to print money, it was surely Windows 95. Before the release in August 1995, Microsoft had sold something over 10 million copies in total of its earlier Windows operating system, over roughly the decade since floating. Within months of release, Windows 95 had been installed – licence fee duly paid – in 40 million PCs in the United States and around the world and Microsoft had blown the competition, notably IBM, out of the water. Since then of course, with the explosion of personal and mobile computing since the late 1990s, vast quantities of Windows in its various iterations have shipped, with the pinnacle to this point being Windows 7 – somewhere between 600 and 700 million sales and still going – but it was W95 which really got Microsoft’s ball rolling.
So why all the naysayers?
Given all of this – and there’s a great deal more which could be and of course has been said about the Seattle-based tech giant’s spectacular success – why should a growing number of industry observers and pundits, who can’t all be disgruntled ex-staffers with an axe to grind, be calling time on Microsoft? More to the point, what should an incumbent or prospective first-time Microsoft investor be making of all the negative noise?
Plot-loss – The case for the prosecution
Various reasons are given for the assertion that Microsoft is losing the plot. We endeavor to distil them here:
1. Historically, the company’s grunt has been in Windows and Office – both these core products are in an inevitable downwards spiral. This is true – The Windows and MS Business divisions (the latter being primarily Office) together contributed nearly 56 percent of gross revenues in the 2012-13 financial year, with net income before tax in the Business division a staggering 65.44 percent of gross revenues, and Windows weighing in at 47.87 percent. So they’re the engine-room at Microsoft but both the operating system and the Office suite (Word, Excel and Powerpoint) are designed for desk-top and laptop computers, global sales for both of which are shedding percentage points annually with the relentless growth in smartphone and tablet usage.
And Microsoft itself, seemingly, sees the writing on the wall with Windows 8, a recalibration of the operating system towards touch and swipe which continues to infuriate legions of PC and laptop users worldwide.
2. Everything else Microsoft makes or does is subject to intense competition and/or the returns are ordinary or worse. Also true – The other major part of Microsoft is its Server & Tools division which last financial year contributed 26 percent of gross revenues, with an operating income of $8.152 billion – some 40 percent of gross. That’s hardly ordinary but Microsoft faces remorseless competition from other heavy hitters in back-end computing, notably IBM (NYSE:IBM), Hewlett-Packard (NYSE:HPQ), SAP (FRA:SAP) and Oracle (NYSE:ORCL).
And in the other division of consequence – Entertainment & Devices, where the major product is Xbox – last financial year’s $10.2 billion in revenues translated into just $888 million in operating income, a margin of 8.69 percent. It’s undeniably a player but Xbox is being beaten to a standstill in its ongoing slug-fest with the Sony (TYO:6758) PlayStation and is being touted as a leading candidate for divestment, quite possibly to Sony (regulators permitting).
However, this division is very much in ‘wait and see’, mode with the impending launch for this Christmas of the new Xbox One, which will again go toe-to-toe with Sony rival, the Playstation 4. The console hardware market has been in stagnation for some time with the last significant upgrades from both companies as far back as 2006. If the market deems the Xbox One superior to the PS4, the balance of power between the duopoly could quickly swing.
3. Microsoft never invented anything or, if it did, it failed to exploit the invention. True-ish – As is well enough known, much of the essence of the Windows graphic user interface was obtained under licence (or otherwise, depending on which rumour you believe) from another fledging company, called Apple. The mouse, so integral to Windows, came from Xerox (NYSE:XRX), via Apple.
And other stuff that made Windows rock also came from third parties, such as the Pagemaker content-making program licensed from Aldus. As for things invented but not exploited, the story is now the stuff of legend as to Bill Gates’ rejection of a device presented a decade ago by a Microsoft design team which looked for all the world like an electronic book.
4. Microsoft buys other people’s clever stuff and makes a hash of them. We’re probably getting a bit subjective here. But as a case in point, back in 1997 Microsoft picked up – for a reputed $400 million – a clever web-based email provider from its inventors, who’d hitherto worked for Apple. It was called Hotmail and over the ensuing years it became the email of choice for literally hundreds of millions – an estimated 360 million in 2011 – of users around the world.
But Hotmail started becoming ‘un-cool’ after Google launched its competing Gmail service in beta format in 2007. Last year Microsoft announced that Hotmail was to be canned and in May this year required all its faithful users to migrate to Outlook, to howls of protest worldwide. The company keeps claiming that in time all Hotmail devotees will come to love the new Outlook but the question keeps being asked in the blogosphere, why would you alienate customers like that?
It’s still early days for Skype, which Microsoft acquired two years ago for $8.5 billion, and even more so for Yammer – the social media you’d perhaps get from mating Facebook and LinkedIn – for which Microsoft ponied up $1.2 billion last year. The thing is though, these products are all someone else’s bright ideas. The impression lingers that Microsoft doesn’t have the wherewithal to do social media or other new-age tech from scratch.
5. New Microsoft products are bombing. So far, arguably yes – In this category of the Microsoft-losing-plot scenario, the example given is invariably the Surface tablet. Designed in-house from the ground up and running the troubled Windows 8, the Surface and its more sophisticated cousin, the Surface Pro, represent Microsoft’s first foray back into a concept it created way back in 2002, with a mobile version of Windows XP and which tanked when OEM hardware suppliers couldn’t make it sell.
And since its launch in June last year, the Surface tablet though praised by critics has been making heavy weather of it with consumers. To the extent that Microsoft booked a $900 million ‘inventory adjustment’ – read unsold stock – in its fourth quarter, a loss of seven cents per share in dividend. To the extent that the tablet is the way of the future, Microsoft on current sales of Surface is simply not in the game.
6. With the Nokia purchase, Microsoft’s desperation is showing. Too early to tell – Microsoft’s used a slug of its cash – around $7 billion – to acquire a formerly iconic phone business which as all the world knows has been leaking market share for years.
Most of that price has gone in goodwill, with the ‘Lumia’ smartphone brand included but not the right to put the word ‘Nokia’ on each Microsoft unit henceforth produced, arguably the more prized asset. When the acquisition was announced, market commentators were quick to draw the analogy of two dinosaurs mating – and producing another dinosaur. Time will tell.
But wait – there’s more
The foregoing is probably enough to be going on with, as regards the central proposition that Microsoft is losing the plot. We might have added a section on, say, ‘toxic corporate culture’ – very much the focus of an in-depth piece by Kurt Eichenwald, entitled ‘Microsoft’s Lost Decade’, in Vanity Fair from August last year. The author had obviously done his homework but for us the notion remains just too subjective a measure of the thesis, so we’re leaving it aside.
Corporate culture-wise though, what could be mentioned is that Microsoft has demonstrated a propensity over the years to be a serial antitrust offender. Just in last year’s accounts, the company booked a $733 million charge for the fine imposed by the European Commission in March and in the prior year accounts there was provision for payment of the $1.4 billion penalty, also courtesy of the EC, incurred back in 2008. So that’s over $2 billion right there in forfeited earnings and, as we noted in our piece on ethical investing earlier in the year [Ethical Investment – Big Business But What Does It Mean Exactly?], Microsoft has racked up some $3.4 billion in European antitrust penalties over the past decade, imposed because of an abuse of dominance – as has been found – primarily in relation to Windows.
The cynical take would be that Microsoft was willing to take those penalties on the chin because of the small, minuscule even, impact they have had on the bottom line. But to the extent that many of the tens of billions in earnings since the launch of Windows 95 can be attributed to its near-monopoly in PC and laptop operating systems, that is manifestly not going to be the case going forward.
The big money was back in the 90s
A common admonition to be found in the small print of advertisements for investment products is that ‘past results are no guarantee of future performance’, or words to that effect. In Microsoft’s case, its heyday is now well past. As noted earlier, the explosion in the company’s revenues started with Windows 95, with the $10 billion per annum milestone being reached in 1996 and $20 billion less than three years later.
So also with the earnings on Microsoft stock. Of that staggering 54,047 percent yield to date on 100 shares purchased on listing back in 1986, more than half of it was generated in a single year. In March of 1999, with Windows 95 into the fourth year of its takeover of the world, a two-for-one stock split and a post-split share price of $92.38 – never since achieved – saw the value of that initial 100-share investment in Microsoft soar from $608,500 to $1.37 million.
And the smart money …
Since then, Microsoft has continued to make enormous profits and pay extremely healthy dividends. But nothing like those numbers from the penultimate year of the 20th Century. Using that same investment results calculator on the company’s website, an investment in 100 Microsoft shares exactly 20 years after the float, on 13 March 2006, would have provided a yield of just 64 percent if still held today. Of course, in the intervening period there’s been the global financial and then economic crisis and every publicly-traded stock worldwide, pretty much, has been hammered. Fast forward to 13 March 2009 and the outlay on 100 Microsoft shares on that date would today be presenting with a much healthier 154 percent return.
But undeniably, Microsoft is no longer the undisputed heavyweight tech champion of the world. That title has been emphatically usurped in recent years by Apple and Google, on any measure you care to use. And whereas in investment terms Google is a relatively new kid on the block, having floated in 2004, Apple is older than Microsoft – it went public way back in 1980. While Microsoft was scaling unprecedented heights in the late 1990s, Apple was – following the ousting of Steve Jobs – more or less flat-lining. But then Jobs came back, the iPod hit the market and the rest, as they say, has been history.
Where’s the game-changer?
Which, when we get right down to it, is what Microsoft has lacked over the years since the heady heights of Windows 95 and, more recently, Bill Gates’ retirement from active management of the company. And, according to a widespread view amongst observers of many ilks, continues to lack. Namely, a real game-changer. Since long-time CEO Steve Ballmer launched his long goodbye in August this year, it’s been hard to find an unreservedly good word in either the blogosphere or mainstream financial media about his decade at the helm.
As noted at the outset, Microsoft is sitting on an enormous pile of cash, and is bound to do something with it. It’s not enough to buy an Apple or a Google though and an existing or a prospective investor in Microsoft shares should first and foremost be looking at what the company has achieved beyond Windows and Office and be asking the question, how likely is it that the success of those seminal products can and will be emulated in the future?
Prices can go up and down meaning you can get back less than you invest. This is not advice. Dealing services provided by Hargreaves Lansdown.