Xbox Spinoff Seen More Likely With Ballmer Exit: Real M&A
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After 13 years of declining value, some Microsoft Corp. (MSFT) investors want Steve Ballmer’s replacement to take bolder steps to reverse the slide at the world’s largest software maker. That could mean spinning off the Xbox video-game business.
Ballmer’s retirement as chief executive officer may clear the way for a potential spinoff of the Xbox unit to unlock shareholder value. While a consumer success with $7 billion in annual sales, it’s one of Microsoft’s lower-margin divisions and doesn’t drive sales of the company’s core business services and software. Xbox may be worth at least $17 billion on its own, based on Nintendo Co. (7974)’s revenue multiple, according to data compiled by Bloomberg. Its value should be even higher given that Nintendo has operating losses, Wedbush Inc. said.
Xbox “looks like an attractive standalone business that could hold up on its own,” said Todd Lowenstein, a Los Angeles-based fund manager at HighMark Capital Management Inc., which oversees $19 billion including Microsoft shares. Xbox “seems like it would be the most mature candidate with the best growth potential and the most established to stand on its own.”
Ballmer’s replacement will be tasked with boosting the stock price and accelerating growth after Microsoft -- now with a market value of $275 billion -- was eclipsed by Google Inc. and Apple Inc. Since Ballmer’s appointment was announced 13 years ago, Microsoft has lost $280 billion in market value as he failed to find a hit with smartphones, Web search or tablet computing.
Ballmer, 57, who took over the CEO role in 2000 from Microsoft co-founder and Chairman Bill Gates, plans to step down within 12 months, the Redmond, Washington-based company said Aug. 23. His last major act before announcing his retirement came in July, when he unveiled a reorganization under which Microsoft reduced the number of its business units to four.
Microsoft’s Windows software runs almost 90 percent of the world’s personal computers, and its Office software is the standard for basic workplace applications. Outside of that, it has businesses ranging from supplying the software that runs servers at the heart of corporate hardware to a version of Windows designed for mobile phones. The company is also trying to compete with Google in Internet search with its Bing product and with Apple’s iPad with its Surface tablet.
If Microsoft’s next leader were to separate the parts of the business that target consumers from those offering enterprise solutions, it may unlock value for shareholders by putting a spotlight on the faster-growing and more profitable divisions, Lowenstein said.
“Whoever the new CEO is, you hope they are given a blank sheet from a strategic front,” said Pat Becker, a fund manager at Portland, Oregon-based Becker Capital Management Inc., which oversees $2.6 billion including Microsoft shares. Microsoft’s weakness on the consumer side of its business “begs the question, is the company ripe for these kinds of spinoffs?”
“I just view the Xbox as its own entity,” he said.
Tony Imperati, a spokesman for Microsoft, declined to comment on the possibility of a breakup. Microsoft’s stock gained 1.6 percent today to $33.55.
The first Xbox went on sale in 2001. The division, which will introduce the third version, Xbox One, later this year, includes game development and an online service that enables gamers to play over the Internet. The business has also announced plans to develop original television content for the Xbox.
Microsoft’s entertainment unit, which is mostly comprised of Xbox, had an operating margin in the past 12 months of just 8.7 percent, versus 34 percent for the entire company, data compiled by Bloomberg show.
Because much of Tokyo-based Sony’s revenue comes from television sets and products other than PlayStation, Nintendo’s valuation makes for a cleaner benchmark. Nintendo’s stock sold yesterday for 2.4 times its trailing 12-month revenue, and applying that multiple to Xbox yields a market value of about $17 billion, data compiled by Bloomberg show.
“There’s some value there that clearly could be unlocked if they chose to go that route,” Tim Schwartz, a money manager at Bloomfield Hills, Michigan-based Schwartz Investment Counsel Inc., which oversees $1.3 billion and owns Microsoft, said in a phone interview. “I’d be in favor of them having two separate companies.”
Xbox’s revenue and profit from sales of the consoles, games and subscriptions to its online service give the unit a standalone value between $20 billion and $30 billion, according to Michael Pachter, a Los Angeles-based analyst at Wedbush. Its lower profitability has some investors pushing for a spinoff as they don’t see how an entertainment device helps sales of software and services to companies, he said.
“A lot of Microsoft investors question why they’re in the hardware industry at all,” he said in a phone interview. “It depends on what Microsoft wants to be when it grows up.”
Not all shareholders welcome a split. Richard Cook, co-founder of Cook & Bynum Capital Management LLC, which owns Microsoft shares, said the company has all the pieces to deliver a more cohesive “ecosystem” than its competitors and that he wants those pieces kept together.
“I would be strongly opposed to Microsoft spinning off Xbox,” Cook said in a phone interview from Birmingham, Alabama. “Part of the genius is not only that it’s profitable in its own right, but it allows Microsoft to put a Microsoft machine in everybody’s living room.”
Without being under Microsoft’s umbrella and having access to the company’s $77 billion of cash, Xbox would risk being unable to fund the investments it needs to stay ahead of its competition, said Brian Blau, a San Francisco-based analyst for Gartner Inc.
“The game business is not easy,” he said in a phone interview. “The roadway is littered with carcasses.”
Spinning off Xbox also would run counter to Microsoft’s vision for the product to play a central role in luring more consumers onto its technology. The company wants to link more features of the coming version of Xbox, such as games, with Windows 8 software and the Surface tablet to help those products that have struggled to catch on, according to Lewis Ward, a research manager covering the gaming industry for Framingham, Massachusetts-based IDC.
A spinoff is “very unlikely to happen,” Ward said in a phone interview. “On the technology side, they’re really trying to incorporate games across all of their software platforms.”
Ballmer’s restructuring plan creates complications for a possible Xbox spinoff, an idea he’s opposed. Xbox hardware, video games and television shows are now in one unit, while the Xbox operating system and Xbox Live have been moved to another.
Whether Microsoft decides to part with some business units will come down to who it chooses to be the next CEO, Schwartz of Schwartz Investment Counsel said.
“If they choose an insider to replace Ballmer, I would say a breakup is still unlikely,” he said. “But if they go the other route and get someone from outside the company who has an open mind and is willing to shake things up, I could see them breaking this up. It makes sense.”