Monday, September 23, 2013

Will Microsoft ever grow again?

In the past year, the rapid decline of the PC industry has become undeniable. The fortunes of HP, Dell and Microsoft have suffered accordingly.

Last week “Lex” at the FT questioned whether Microsoft was properly valued as a legacy IT company:

The shares trade at 11 times this years’ earnings and a free cash flow yield of 9 per cent. Cheap? Those figures look a lot like those for IBM and Oracle, the other gigantic clanking technology relics. But it is hard to argue that they face mortal threats to rival Microsoft’s.

Those who hold the stock are betting that the core businesses will be surprisingly stable, and that investors will reap the rewards. That second point is important.
With the accelerating collapse of Blackberry, Microsoft’s quixotic acquisition of Nokia’s handsets has a better chance of gaining share. However, being #3 (with a 15% share) of a low margin business is hardly going to replace being #1 (with a 80-90% share) of a business that once yielded 90% gross margins.

For the benefit of us long-suffering Microsoft shareholders, Lex recommended two steps. The first would be to shut down the online services division — including Bing — after losses last year of $1.2 billion.

This would be a monumental admission of failure — in timing, strategy and execution — to profitably enter the only software business that’s going to matter in 10-15 years. Intelligence continues to migrate to the cloud and software as a service — not software as a package or download — will be the only business of large consumer software companies. Microsoft’s exit would leave Google the sole contender for the foreseeable future, with Amazon and Apple seemingly consigned to specific niches of the business.

Steve Ballmer can’t (and won’t) admit that failure, but his successor could. Growth with heavy losses is not something that any shareholder wants, but if online services are dropped, so are any hopes of online services providing growth.

The other Lex recommendation is to reduce share buybacks (since management “has done a terrible job” of recognizing when its stock is cheap) and shift that money to increasing the dividend. As someone who owns Microsoft for its dividend (as one of the 10 Dogs of the Dow) I’d heartily endorse such a plan. With revenues stagnant and declining margins, shareholders are unlikely to see any significant capital appreciation, so sharing (rather than squandering) Microsoft’s legacy profits is best shareholders have for a return on their investment.

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