Why Microsoft May Be a 'Classic Value Trap'by
The early days of January are typically a time of unbridled optimism. This will be the year we lose 10 pounds and learn to speak French; Japan will turn itself around; Microsoft stock will pull itself out of a decade of doldrums.
Most analysts are betting that the Redmond computer company’s time has come. The company’s fiscal-year revenue has nearly tripled to $74 billion in the last 10 years. At $27, the shares trade right at their 10-year average and yield more than it costs the company to issue debt. Redmond has Skunk-Worked an exciting new tablet and operating system it’s eager to showcase. It’s all backed by ridiculous amounts of free cash and a fortress-like balance sheet. The 12-month price target on the stock forecasts a 25 percent gain.
Still, the company has attracted at least one major detractor with a big megaphone: Barry Ritholtz, an asset manager who runs a quantitative research firm and founder of the well-trafficked blog The Big Picture. He considers the company a “classic value trap,” not unlike what its customers Dell and Hewlett Packard were at the start of this annus horribilis. The problem, he says, is Microsoft Chief Executive Officer Steve Ballmer. “As long as he is running the show—he has missed every major trend in tech over the past decade—I have no confidence in the company.”
He has company. Activist investor David Einhorn has wanted Ballmer out for more than a year and was long the shares in hopes that such an ouster would boost Microsoft’s returns. The stock is up 3 percent this year, compared with the S&P 500’s 14 percent gain. The 13 years since Ballmer became CEO have included the Vista debacle, a thankfully thwarted bid to overpay for Yahoo!, the ceding of search supremacy to Google, and Apple’s envisioning and dominating much of the smartphone and tablet markets. Meanwhile, where’s that “Skype Phone” in every palm?
‘Value trap’ is a funny term, says Bill Koefoed, Microsoft’s general manager of investor relations. Microsoft, he says, is trading in line with the big-cap technology sector, which has recently been out of favor with investors.
“Enterprise tech hasn’t been as sexy to the press. But our relevance to the enterprise has grown in a huge way. Our database business is growing faster than Oracle’s and IBM’s.”
Koefoed says people focus on Windows, which provides a quarter of Microsoft’s overall revenue, but not on the comparable 25 percent contribution from the company’s servers and tools division, which he emphasizes that Ballmer has grown, from a $3 billion business, to a $19 billion enterprise over the past decade. ”Over time, the stock price works itself out. We’re doing a whole bunch of things to be shareholder-friendly. Over time, that will be reflected in our share price.”
Meanwhile, Koefoed says, it was under Ballmer that the company initiated and consistently increased its dividend—with Microsoft shareholders overwhelmingly backing the CEO last month.
Ritholtz is unpersuaded “Think of the difference between what is revealed by a single snapshot of Microsoft today vs. an extended video. Yes, you can see the current situation of lots of cash, a low price-earnings multiple, name recognition, enterprise usage. But what about the trajectory and changes to the underlying market for their goods and services?”
He says that other than Kinnect for Xbox 360, “it’s hard to see what Microsoft gets for its billions of [research and development] dollars.”
“The competitive landscape has been moving against Microsoft,” wrote N. Landell-Mills of Indigo Equity Research after Microsoft’s “uninspiring” latest quarterly report, which involved the company raising its dividend 15 percent. The analyst called the organization “un-innovative and complex” and “a digital dinosaur.”
The full rollout of Windows 8 could, of course, change that state of affairs. Not that early signs are promising.
With the PC replacement cycle stretched out and assailed by competition that Microsoft failed to oppose, Ritholtz has taken to comparing its fate to that of Maytag. “It was,” he says, “once hugely successful and innovative and created lots of products and markets. Now you replace your dishwasher every 10 years; that’s the only time you ever think of Maytag.”