What we have here, is a failure to communicate
The new Financial Analysts Briefing was created by MSFT in the wake of last April's spending-related guidance surprise and massive subsequent stock decline. Its goal is to enhance visibility (not create more uncertainty) in advance of April's formal guidance. With that in mind, what did Ballmer intend to communicate wrt Windows growth expectations for FY '08? After all, given that Client is MSFT's largest and by far most profitable division, it's a critical question, and confusion over its answer cost shareholders $7B on Friday alone. BTW, if you're keeping track, that's the biggest one-day selloff in...well, just the last 9 months (this being MSFT, after all). And that's on top of the recent meltdown, which a commenter pointed out (via a link) was so bad that "one more down day and we would have been tied at nine for the longest tumble in the company's 20-year trading history."
The entire issue comes down to parsing the meaning of Ballmer's numerous vague and even conflicting statements. Armed with the official transcript, which wasn't available for my last post, let me demonstrate. Here's the salient part of his first comment on the issue:
I think some of the revenue forecasts I've seen out there for Windows Vista in fiscal year '08 are overly aggressive
Hmm...okay "some" are overly aggressive - not great, some bad headlines in the media, stock will be down next session (but you knew that already because Ballmer was speaking in public and to the financial community no less). Overall, no biggie. Oops, spoke too soon - he returns to the issue in the Q&A:
The thing I think there's a disconnect on for most folks whose models I've read is there's a disconnect between what people think is the growth of the PC market and what they think is Vista growth.
But if we were to say where do we think people are maybe not seeing the business the same way we are, it's primarily in Windows revenue and it's primarily because I don't think people have the same mental model I have of how we build Windows revenue.
Whoops...now it's "most folks whose models I've read", and "people" generally (but even then only "maybe" - or is that heading to definitely by the end there?). But perhaps Steve only reads models from the high-end lunatic fringe, while dreaming nostalgically about the good ol' days, and he still means just "some". Not likely? Damn! So those could be mainstream models, aka "consensus", aka "he just guided down", aka "look out below"? Let's see if further refinement helps:
And my basic assumption is we'll see a small surge, but a small surge doesn't mean a market that's 220 odd million PCs goes to be 200 -- if normal growth is 7, 8 percent, 9 percent developed market, it's not going to go be 12, 13, 14, 15 percent.
Uh oh...consensus definitely fit within that "12, 13, 14, 15" range. Seems like he's now talking about the "majority" vs the "some" he started out with. If so, the stock's going to take a bigger hit - should have bought those short-term puts after all. Maybe he didn't mean it the way it comes across. What else did he say?:
And the things people forget is a new Windows release is primarily a chance to sustain the revenue we have.
Holy shit... Now he's calling for no growth? Bye bye stock. Note to self: consider buying deep out-of-the-money, long-term puts on MSFT.
So, in summary, when April's [formal] Windows growth forecast for '08 arrives, it's likely to be somewhere between 0 and 10% depending, of course, on which of Ballmer's comments you decide to place your emphasis. How's that for increasing visibility? Which explains why reactions run the gamut from this relatively benign interpretation (from a firm with an investment banking relationship with MSFT - though I'm sure that posed no conflicts):
Ballmer did a poor job of communicating realistic expectations about Vista growth," wrote Credit Suisse analyst Jason Maynard. "He suggested that a few sell-side models were too aggressive on this front. Unfortunately, the message came across to many that Ballmer was trying to talk down consensus Vista revenue estimates, rather than just a few outliers.
To this rather harsh one (which, sadly, contains elements of truth that are hard to refute):
Ok, so in English, what I hear Steve really saying is:
1. 2008 Vista revenues will not meet expectations; therefore
2. Microsoft will incur lower operating expenses, because we just aren't selling what we'd hoped; and
3. Since we don't have many attractive ROI opportunities in our core businesses we'll continue to buy back gobs of stock; and finally
4. We may need to further scramble in search and other means of online customer acquisition since we are continuing to get the crap kicked out of us by Google.
After reviewing the transcript carefully, I've changed part of my earlier opinion and now believe Ballmer was guiding down consensus estimates vs just the high-end estimates of "some". That makes sense logically as well. Let's face it, this was not the time or venue for raising that particular concern if the issue was simply a few overly-bullish outliers. On the other end of the spectrum, I don't believe for a minute that Ballmer meant to infer 0% growth when he stupidly said "sustain the revenue we have". Therefore, come April, I think MSFT will guide somewhere between 8-10% growth for Windows revenue, while hoping to actually do 9-11%. That means consensus revenue estimates are going to come down materially. Luckily, based on Ballmer's comments, earnings estimates should escape largely unscathed. However, UBS's Heather Bellini (one of the top-ranked software analysts) warns that there's still a potential shock to come on the COGs side related to Xbox.
Netting it out, the stock is likely in limbo - or freefall - until all this gets resolved in April. Meanwhile, the market will be digesting the long-term implications of Vista's first full year of sales being good for just a 1-2% pop over general PC growth despite a 5 year gap and some $6B spent. Additionally, focus will be on Ballmer's comments around the likely contribution from the original "emerging bets" - which seemed to be that, while competitors like AAPL and GOOG have been busy since '00 investing $100M's to now reap much higher growth rates than MSFT and $B's in profits, MSFT has been busy investing $10B's of profits to now make revenue growth look a little less anemic and maybe - in another year or two - stop collectively hurting the bottom line by $100M's. Again, the long-term implications of that are likely to cause indigestion on Wall Street - especially with Ballmer calling for even more "investments".
Finally, you have Ballmer's seeming confession that, moving forward, MSFT will only be able to maintain the % of industry profits that it has enjoyed since '00 if it continues to ramp spending and everything goes right (read: the sun, wind and moon align). That's important, because this is the convoluted "growth" metric he's been hanging his hat on since all his earlier company-specific ones failed to capture Wall Street's interest. So ask yourself this: if MSFT's stock has badly underperformed all major indexes for most of the past 5 years as MSFT did maintain X% of the industry's profits, how's it likely to fare over the next 5 if the CEO's best-possible case is for that to continue (at huge cost), leaving the more realistic case that it doesn't, and him having to abandon that one too? Yeah, that's what I thought as well...
Update: And the campaign of disinformation continues: