Sunday, February 18, 2007

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.

And again:

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. 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:


  • Ballmer obviously meant "sustain current revenue GROWTH" not "sustain current revenue." Misspoke (surprise). The missing point is, the big bang release was a mistake, they should have been dribbling for the last five years and gradually raising prices. And that's what they'll do now.

    By Anonymous Anonymous, at 5:20 PM  

  • I have come to the belief that Microsoft's long term financial strategy is to continue large stock buybacks - which from a certain internal perspective is not a bad thing, but is very frustrating to us shareholders. (Not the mention employees with underwater options from the old days that are approaching their expirations.)

    By issuing this type of "guidance" Ballmer is doing his best to ensure MSFT stays as low as possible, as long as possible. This keeps the price within their buyback budget for N shares over the next X time span.

    By Anonymous netdef, at 9:18 AM  

  • At this point, Ballmer can't even put lipstick on a pig without soothing the pig by talking about BLT's and good BBQ recipes.

    By Anonymous Anonymous, at 11:08 AM  

  • Vista shoulda been the super fast must have tight coded runs on current rigs OS; instead Vista is bloated slow DRM embedded over priced non-trusting money means everything to M$ OS.

    Go figure, I own MSFT and now run openSUSE

    By Anonymous Anonymous, at 6:53 PM  

  • FYI - "M$" references or other clues that you're a rabid ABMer vs someone concerned about the health of MSFT, will almost always result in your comment being round-filed. I let this one through because it starts out with a point.

    By Blogger MSFTextrememakeover, at 8:38 PM  

  • Another great post...and so soon. IMHO...Ballmer is in a completely non-defensible position. If he admits that the information in this briefing is "on strategy" and that needed to be said for any longer than a few months, then he's completely failed to course correct months ago when he should have. If this information is the result of a surprise, like he woke up one morning, and someone plopped this down on his desk and he was shocked, then he's not in touch with his business...also bad. If he's spinning this negatively in order to lower the stock price for a buy back (something he would never admit) then that's criminal and the SEC needs to be on his ass.

    In the end, it's just bad all around. He obviously doesn't even have an advisor who can pull him aside and just tell him to shut up and that given his track record, someone else needs to speak for the company. Did he honestly think that this time would be different?

    We need a NEW CEO!!!!! Really, I'll do it for a third the money.

    By Anonymous Anonymous, at 1:14 AM  

  • You've completely missed a major aspect of the debate. MSFT will benefit from a shift in deferred revenue recognition in late 2007 and fiscal 2008. The company may or may not have been able to determine if analysts were counting this revenue in their FY 2008 estimates. I don't think the range of revenues they're implying is all that different from what the street had, but we'll see soon. Also, since even MSFT may not really know what it will be, they're erring on the side of caution.

    By Anonymous Anonymous, at 7:03 PM  

  • "You've completely missed a major aspect of the debate."

    I had it in originally but both posts were running too long so I cut it. I think it's addressed in one of my linked coverage articles but it's worth noting - so thx. [Update: It is. See Bloomberg article in previous post] However, keep in mind that it was MSFT who decided to change the way revenue was recognized. So again, who should carry the blame for the resulting confusion?

    By Blogger MSFTextrememakeover, at 10:50 PM  

  • Incredible. $1.52B for a patent thing. That's amazing. And what is more amazing is that Ballmer talking to the financial community still has more negative impact than a massive legal judgement against us.

    By Anonymous Anonymous, at 6:23 PM  

  • OK, so today on the market, not really our fault (how rare), but honestly, do you know how much time it's going to take our dismal performance to recover from this drop. We suck.

    By Anonymous Anonymous, at 4:22 PM  

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