Saturday, December 30, 2006

Too close to call

Friday marked the last day of trading for 2006, so I took a break from my post-Christmas turkey and chocolate induced coma to check on how MSFT closed. Recall that the latter-half, buyback-fueled (at least in part), charge had put MSFT in contention to meet or even beat the S&P this year. A review of the final numbers yields some interesting contradictions. For example, Investor.msn and Yahoo show MSFT finishing the year just shy of the S&P (eyeball approximation from msn.investor shows ~11.3% versus the S&P's ~11.8%, excluding dividends). That's pretty close, but as the saying goes, Close only counts in horseshoes and hand grenades. Bigcharts, on the other hand, shows MSFT slightly ahead. Looking at the raw data, the difference appears to be that the former sites are using market close prices as the default, whereas others - like Bigcharts - are incorporating the opens as well. For example, if you use the January 3rd open versus close (MSFT had quite an intraday swing that day), MSFT slightly beat the S&P with a ~13.75% return versus ~13.6% (dividends excluded). So, depending on how you look at it, MSFT has either underperformed the S&P 3 of the past 4 years, or all 4. The net underperformance over that timeframe is ~45%. On the less contentious side, MSFT's '06 performance was sufficient to clearly beat the NASDAQ - something it hasn't done since 2002 ('98 in a positive market).

Regardless of whether MSFT missed or beat the S&P this year, it's close, and most investors (as opposed to traders) measure performance over something more than simply a one-year period. To assist in that, I took some numbers from Investor.msn for the period 1998-2006. Note: these are eye-balled approximations using the default closing numbers and don't include dividends - though given MSFT's lousy below-market dividend, that actually benefits them in most years but '04 (the year they paid the massively-stupid $3 one-time). Here's the result:

What's your take on that track record of performance? You already know mine. How many of you out there could underperform your peers by almost 50% over a 3-4 year period and still retain your job? I suspect very few, but apparently Ballmer et al are working under different constraints than the rest of us. Maybe he had an advance agreement with the Board to take this decade off and just forgot to inform shareholders? :-)

More importantly, what does '07 hold? Fortunately or unfortunately, the bulk of the failed-tender related buyback needed to be completed by year-end ['06] in order to reduce the share base sufficiently to make the revised yearly numbers (which had been bumped up on expectations that the tender would complete). Therefore, a good part of that catalyst should disappear or at least diminish come January. That still leaves the increased regular buyback ($20B), which may or may not be used in '07. If so, that might help. But as we've seen over the past 4 years, even $10B's of buybacks haven't been able to do much more than provide support. Oh, and let insiders trip over themselves cashing out ridiculously generous pay packages at higher prices (than would likely have prevailed otherwise), while telling us what a great job they're doing on our behalf.

The real determinant in '07 will therefore be the general market backdrop (a rising tide lifts all boats, as they say). Also critical, will be MSFT's ability to finally start driving some meaningful bottom line earnings acceleration in excess of what the street already expects. Personally, I don't see that occurring in '07 unless Office and Vista really take off (longshot - at least in '07), MSFT sandbagged the impact of the generally higher-priced Vista skus and accelerated accounting recognition (likely), or the company finally gets serious about cutting headcount following the Office/Vista launch (much needed, but doubtful). As always, any surprise "good news" from all the money-losing divisions would also be constructive - like say a profit.

Personally, I saw some signs this year that MSFT's management is finally acknowledging - or being forced to acknowledge - the need for substantial change. While that's almost 5 years later that it should have been, better late than never. However, if they continue making changes at the current glacial pace, then MSFT's best days are definitely behind it.

On a related note, Joe Wilcox has some advice for MSFT heading into 2007:

My list would be somewhat different, and I might actually do one for a future post. In the meantime, he makes some good points and it's worth a read.

Thursday, December 21, 2006

Somebody pinch me

I haven't posted for a while because, frankly, there's been little of interest and I'm more preoccupied with Christmas - oops, I mean the holiday (we must be politically correct after all). Yes, there was the comical reiteration that Zune sales were going as planned - while simultaneously speculating about increasing the marketing expenditure, more bad news on the search front, another [yawn] partnership announcement, more fallout from the Novell deal, and of course more legal and product bug problems (too many to list there). But that's mostly business as usual and hardly noteworthy.

What is new, is that after breaking the uptrend and seemingly poised for another trip to the basement, MSFT stock suddenly reversed, and managed to close above $30 - something it hasn't done in 2 years. In fact, it's currently threatening to take out the high on what is now a 4-year old trading range. Of course, before we get too excited, we should note that this didn't happen in a vacuum. Getting here, first took a trip to the bottom of that 4-year range (following management's guidance screwup), and then an additional $40B commitment of [shareholder] cash to a tender (which subsequently failed) and an increased buyback. Still, if you held through all that and ignore the implications that MSFT can't buy its way out of trouble forever, you're currently poised to receive an S&P-like performance for the first time in 4 years (ignoring, of course, that you took far more risk, incurred more volatility, and made less in dividends to get it):

Speaking of dividends, I see that management has decided to reward long-suffering shareholders by not increasing the dividend at all. I've posted before on the unmitigated joke that is MSFT's dividend policy, but that's even more true given the recent runup which has dropped the yield to just 1.33%. It's hard to decide what to make of the Board's decision to leave the dividend alone when it's under-market and the stock has [still] badly underperformed the S&P since '00 - to the tune of some 50% . If you want to be charitable, I guess you could say that a) they believe that money spent on buybacks is more effective (difficult to support since they clearly have enough cash to do both), or b)they're bullish about the year ahead and think that the stock can continue its recent stronger performance w/o further assistance. On the less-charitable - but likely more realistic - side, you could conclude that a) they think the stock has gotten ahead of itself and will drop, thereby increasing the yield, b) they're momentarily giddy over performing at the market for once (and haven't figured out that it required committing $40B of additional shareholder cash and even then, including dividends, you'd still have been better off holding the SPY's vs MSFT), or c) they couldn't care less and don't intend to ever provide even a market-average dividend (consistent with the track record since its inception).

Meanwhile, MSFT's Dare Obasanjo is openly blogging that he used the $30 breach to bail on all his options. He's entitled, of course (assuming, that is, that as an insider - albeit a non-executive one - there's no SEC restriction about doing so publicly), but it doesn't say much for his optimism in the company's future - as a commenter on his post noted. Then again, neither does the level of [executive] insider selling generally. It seems that many, especially in MSFT's leadership, are happy to simply give up on ever driving value for shareholders. Instead, they seem content to run the company for their own personal enrichment, while throwing shareholders just enough occasional bones to keep them at bay. It's almost like they got used to a certain lifestyle back in the 90's - when the company used to perform for shareholders - and now think they're entitled to that for life. If so, wake up. To quote a Neil Diamond song (why, I'm not sure, but it popped into my head), "Used-to-bes don't count anymore..They just lay on the floor...Till we sweep them away.". Translation: Stop living off your former glory - that's in the increasingly distant past. Either perform now for current shareholders or make room for a leadership team who can/will. The S&P index is the "average" of a broad cross-section of companies. If you can't even perform at that average more than once every 4 years (I.e. are consistently "below-average"), you have no business cashing multi-million dollar pay packages and splitting $1B bonuses.