Thursday, July 26, 2007

Like us, or leave us

That's the effective message Ballmer et al delivered at today's Financial Analyst Meeting. BTW, the market decided to go with the "leave us" option, although it's up a bit in after hours:

Before you say, "But hey, the market was down too". It was. However, most stocks rally on presentations to the financial community. After all, the objective of the exercise is to provide that group with greater insight into management's thinking and strategy, thereby making them more confident, not less. I would also remind you that the exact same thing happened last year. Finally, I would point out the large volume (~88M shares) and significant end of day selling (red):

I was originally going to cover the FAM in detail, but on reflection why bother? Most of it was the same tired, old, self-serving drivel we've heard before. And yet the current management team still thinks that maybe, just maybe, someone will buy it.

The stupidity can be summed up in this statement by Ballmer, which came early in his speech:

If you take a look over the last five years, a lot has gone very well from a shareholder perspective.

He went on to discuss revenue and earnings growth over this particular time period, which of course avoids highlighting the rapid ramp in costs during the past three years (the period, incidentally, that he used when referring to shareholders with [implicitly] too short of an expectation time frame). While Ballmer deserves some kudos for top line growth and - much less so - bottom line earnings during this time frame, the ultimate test for investors is how the stock did. As per usual, Ballmer omitted that little gem. So let's fill in the missing data point:

BTW, that's sans dividends. With dividends (including the one-time $3 fiasco), it would be another 14-15% higher. So call it just a 60% under performance versus the NASDAQ (although the QQQQ's, for example, pay dividends as well). Maybe it did better versus its peers? Let's check:

Er, nope (that's MSFT at the very bottom btw).

It boggles the mind that the CEO of a company whose stock has chronically underperformed the index and its peers by that magnitude, and is currently trailing the NASDAQ by almost 7% YTD (in this its major product release year), can actually stand on stage in front of investors/analysts and claim that "a lot has gone very well from a shareholders perspective". Even more incredulous is that not one of them called "bullshit!".

I'll at least give credit to CFO Liddell for doing what no senior MSFT executive has done in recent history, and that's mention the stock proactively:

Probably of more interest at the end of the day is what that looked like from a shareholder point of view, and that translated into the total shareholder return of 28 percent for the year.

Of course, it was also self-serving and primarily reflects how badly MSFT had crashed the year previously following Ballmer's now infamous spending surprise - a point that Liddell semi-acknowledged:

And, obviously, some of you will say, Well, it was at a low point last year, I could have gone back two years, and it would have been around 25 percent.

BTW, my math for the past two years - again, sans dividends - is more like 19% (~22% with). Unfortunately, having won some points by mentioning the stock, Liddell descends into the same self-serving nonsense as everyone else:

But measure it however you like, last year was the best financial year from a shareholder perspective that we've had this decade, at 28 percent.

Again, it's unbelievable to me that Liddell and others can brag about this with a straight face and no one challenges them on it. Seriously, the translation here is: "Forget the fact that this was in large part a rebound after crashing to three-year lows (following our gross incompetence in managing street expectations), that it came at the cost of another $27B of shareholder cash poured into a tender and buybacks, that it was helped by the hope that Vista was going to be a killer release (now dashed btw), and that it came after badly trailing all major indexes so far this decade (along with the largest destruction of shareholder value in corporate history). Isn't it great?".

That said, Liddell's speech is the only one I found any value in. It's worth a read. He also seemed to foreshadow some improvement in the dividend strategy (which has been a total mess so far). Although he still expressed a preference for buybacks vs dividends. Why, exactly, was left unsaid. Except, of course, that dividends actually go to shareholders, whereas buybacks can be claimed as "returned to shareholders" when in actuality a large part historically has gone to offsetting the dilution caused by paying insiders.

Bottom line, unless shareholders finally push back and call for new management, expect the next five years to look like the last five - best case. While others are spending far less on R&D and reporting massive earnings upside:

MSFT management is calling for no earnings acceleration because they're going to keep spending ridiculous sums on suspect "big bets" and failed business models like Xbox, while continuing to under execute wrt delivering core products that actually thrill users and generate word-of-mouth buying excitement. As regards the stock, expect it to continue to under perform. After all, who wants a mature 8-10% grower that's still spending like it's a high-growth company - and rewarding its upper echelon accordingly - because its management is ineffective and in denial?


An interesting round up of analyst impressions coming out of the meeting:

I guess it must be some of the other institutions represented by the 100-odd professionals who follow the stock that are selling :-)


  • The (lack of) response from the shareholders has got to be the most baffling thing I've seen in years. The executives make the EXACT SAME SPEECHES every quarter, yet the stock goes nowhere, the billions in the bank sink lower, and no one seriously questions anything. I've pretty much given up on the stock at this point.

    By Anonymous Anonymous, at 2:11 AM  

  • I remember years ago reading an analysis on Microsoft claiming that it was lined up to be the next Worldcom. The option obligations it had to employees were not booked as a liability, and the effect of meeting those option prices on the stock was going to be unbearably huge if it kept its growth curve. I forget who did the analysis -- some grandstanding contrarian investor. But it always stuck in the back of my head.

    Since I started reading your excellent blog, I have often found myself wondering if MSFT's management has deliberately tried to keep the stock flat to avoid ever reflecting that liability. I'm no expert on financial derivatives, but it seems at least plausible that holding static is intended to avoid that later shock.

    Not that I'm saying this is good or bad. I am unable to evaluate the merit of such a plan. And as a competitor to MSFT, I frequently find myself wishing the stock would finally collapse and smash into a million pieces. So I'll admit to a bias in the matter. :-)

    By Anonymous Nathan T. Freeman, at 3:35 AM  

  • * Ahem *

    "If you take a look over the last five years, a lot has gone very well from a shareholder perspective."

    Ballmer to Realist Translation Engine Output (TM):

    "It didn't crash during the last five years."

    By Anonymous Anonymous, at 10:08 AM  

  • Then there's Bach:

    "Now, if you think about fiscal year '07 for us, and you look at it sort of at the top-line financial point of view, you'd have to say, Gosh, this wasn't a particularly successful year, particularly if you think about the billion-dollar warranty reserve and the work we've had to do around that. But I do want to give you some color for performance across E&D, because I think it's actually quite different, depending on the various businesses that you look at."

    By Anonymous Anonymous, at 10:33 AM  

  • "The (lack of) response from the shareholders has got to be the most baffling thing I've seen in years."

    Agree. When it comes to MSFT, it's like shareholders and analysts suddenly forget their brains when in the presence of Ballmer and Gates. The simple question that went unasked was "If the strategies are so good, and you're tracking so well against them all, then how come the stock has done so badly, for so long, relative to the market and most peers despite massive buybacks?"

    By Blogger MSFTextrememakeover, at 11:57 AM  

  • The fact of the matter is that the shareholders are voting with their feet and not with their shareholder votes and we need both. They're quicker to sell and sell and sell, driving the price down...rather than stick it out and try to institute change. Of course it is easier to sell, but the more do it, the more it becomes counter productive to seeing shareholder growth.

    Personally, we need to dump Live and H&E and pour the money into the core products and enterprise space where we can just blow out the numbers IBM style in terms of volume and server licensing.

    By Anonymous Anonymous, at 12:18 PM  

  • Re: the conspiracy theory about options is interesting. In July 2003, the beginning of FY04, MS switched from options to grants. Most options vest over 4 years, and expire after 7. So the last group of options will expire in FY'15--a whopping 7 more years from now. I wonder if we'll suddenly start to see the stock take off after that?

    I personally think that MS management couldn't care less about the stock price, and is managing the company for long-term stability contra to a very volatile sector. They want to make sure that Microsoft's still a cash-generating machine in 5, 10, and 20 years.

    Which makes it not such a good stock to be holding.

    By Anonymous Anonymous, at 12:32 PM  

  • I personally think that MS management couldn't care less about the stock price, and is managing the company for long-term stability contra to a very volatile sector. They want to make sure that Microsoft's still a cash-generating machine in 5, 10, and 20 years.

    Well they get their stock as a grant so as long as it's in double-digits partners and above have what looks like an infinite gravy train. Maybe the execs should get options instead of grants as well? You'd certainly see some more attention being paid to the price then.

    By Anonymous Anonymous, at 2:05 PM  

  • There are two sets of stock options left (beyond the ones that expire in a couple of days - underwater... AGAIN). Microsoft went back to 10 year options in 2001, so the options expire on 2/12/2011 and 7/31/2012. The 2001 options are priced at $26.44 and the 2002 options are priced at $21.59. I don't remember why we got options in Feb 2001 instead of the normal July options.

    The July 2000 options that expire on 7/31 are priced at 31.42, so we have basically lost $1.50 per share in 7 years.

    I wonder why they didn't show a 7 year chart at the FAM?

    As for partner upside being tied to stock performance, I totally agree. They should get a derivative that let's them participate in dividends and stock growth - just like the rest of the shareholders. Until that happens, the partners are going to run Microsoft like their own private entitlement fund because that's what it is. As long as they don't do something to get fired, they are guaranteed a 7 figure pay off, great benefits, lots of perks, and a liberal vacation policy. Not sure you can find an easier million dollar a year job...


    By Anonymous Anonymous, at 9:45 AM  

  • "I don't remember why we got options in Feb 2001 instead of the normal July options."

    There was an extra grant in there somewhere after the crash when employee angst was rising.

    "I wonder why they didn't show a 7 year chart at the FAM?"

    Yeah, I wonder? :-) Indeed, if it weren't for the fact that the stock had finally outperformed on the year after its crash the year previous, the stock would have gone unmentioned - as it has every other year. The current management team has basically abdicated all responsibility for the performance of the stock (unless of course it happens to have a good year regardless of causation) and, so far, shareholders are letting them get away with it.

    By Blogger MSFTextrememakeover, at 11:10 AM  

  • Again, it's unbelievable to me that Liddell and others can brag about this with a straight face and no one challenges them on it.

    Microsoft Investment Requires Too Much Patience - Barron's:
    "Goldman Sachs said last week that large-cap-growth mutual funds are very underweight MSFT: the average fund has a 1.23% stake, compared with a 3.3% Russell 1000 growth index rating. Some of the issues that worry analysts:
    1) It was clear from the presentation that many of the growth prospects will take 5-10 years to bear fruit.
    2) The company overspends ("nothing would delight analysts more than a nice big round of cost-cutting.")
    3) The businesses MSFT says it's entering (e.g. advertising and consumer electronics) are far more cut-throat than its current mix.
    4) Microsoft's focus on building internet infrastructure rather than building sites that bring in users is "backward."
    5) Bill Gates's plan to pass control of product development to Ray Ozzie "will not be a smooth one." "

    I suspect it's not so much that analysts don't see the cognitive dissonance, it's more that they're past caring. Absent any material change in MS leadership, MSFT FAM's and conf calls have become merely a 'check box' in analyst due dilligence. These analsysts aren't looking to demonstrate who's the smartest person in the room. Why ask questions to which the answers merely waste bandwidth?

    By Anonymous Charles, at 9:40 AM  

  • A follow up comment on the futility of attempting substantive Q&A with MS management:

    Gates sees no Google threat in phone software:
    "How many products, of all the Google products that have been introduced, how many of them are profit-making products?" the Times quoted Gates as saying.

    "They've introduced about 30 different products; they have one profit-making product. So you're now making a prediction without ever seeing the software that they're going to have the world's best phone and it's going to be free?" the paper quoted him as saying.

    Arguably, this is the pot calling the kettle black.

    By Anonymous Charles, at 8:21 AM  

  • Sorry this is a late comment, but I just read the original post.

    I'm a former partner at Microsoft (I left at the end of 2003) and I couldn't agree more that the partner compensation scheme is designed to reward insiders but with zero accountability in return, let alone align incentives with shareholders.

    I was asked to participate in the internal focus groups about the new comp scheme, where they said they wanted to tie the RSU's (restricted stock units) to customer satisfaction. I thought this was stupid.

    In front of the group -- in front of the head of HR at the time, in fact -- I said, "If the intent is to get people to act differently than they would otherwise, this wouldn't do it. Customer satisfaction is too abstract a metric from a line management perspective, it's the sum total of a lot of things done right or wrong. What can Microsoft Research do that can possibly impact overall customer satisfaction, for example? If you want to impact customer satisfaction, then you need to tie it to metrics that are closer to home, that are known to impact customer satisfaction, e.g. quality, service, etc. The specific metric will be different for different teams. But it needs to be a metric that people know how to influence up or down, or else it's this abstract thing. You might as well tie it to the stock price, something else that's the sum total of a lot of factors."

    They looked at me and said "But that would be hard." I was flabbergasted. I said, "Look, you either want to incent specific behavior with this new policy or you don't. If you want to create a policy that pays people one way or the other, no matter what they do, you can do that, but if you are trying to impact customer satisfaction, this isn't the way to do it."

    Sure enough, they did what was easy, tying comp to an abstract number no one knows how to change.

    One of the reasons I left Microsoft is that I realized I could work half as hard or twice as hard and achieve the same results and be compensated the same. I didn't want to live my life that way, so I left.

    By Anonymous Anonymous, at 8:32 AM  

  • It is truly sad to see what our executive management has done to destroy this company. There is absolutely zero accountability across the board for our partner level executives. Even worse - it is well known within the company that the goals and metrics that partners sign up to are almost always totally sandbag numbers that they know they will hit. This guarantees that they will acheive their accellerated SPA's (restricted stock). It is also well know that when they look to be missing their #'s in any one of the business they will manipulate the measurement of the goal to make sure they get their fat paydays.

    Take search as an example. SPSA awards had a goal of increasing seach share by some 5% or so this year. Now everybody knows that MSN/Live search share is totally in the tank. But somehow miraculously they made a 5% gain in search just the month before measurement for partner SPSA's. The dirty little secret is that this share was totally artificial.

    Almost none of these new searches are people seriously looking for things on MSN or Live Search. And some people even say that most of these searches are not even done by actual real humans. They are bots that have been scripted to win prizes from MSN's over funded marketing machine. Does anybody remember MSN giving away $400 for every new narrowband subscriber? Here we go again on search.

    But hey - you can't get to the truth. No partner wants the truth, it gets in the way of the million dollars they get every year no matter how many horrible a job they do.

    Like somebody else here said. Being a Microsoft partner is the easiest million dollar job in the world. No accountability, tons of vacation, lots of fancy offsite meetings spent strategerizing, and never really having to do any hard work. It's a great gig if you can get it...

    And for those of you who say "he's just jealous" you bet your ass I am!

    By Anonymous Anonymous, at 11:51 PM  

  • 242.7 million shares bought back in Q4 at $30.35 a share and the stock closes at $28.96 today. Oops. You have to wonder how much these buybacks have propped the stock up over the past several quarters.

    By Anonymous Anonymous, at 4:41 PM  

  • "242.7 million shares bought back in Q4 at $30.35 a share and the stock closes at $28.96 today. Oops."

    They were bought back in a range from $28.17 to $30.71 - the bulk at the latter. What's your point?

    By Blogger MSFTextrememakeover, at 10:08 AM  

  • The buyback didn't make the price better.

    By Anonymous Anonymous, at 1:42 PM  

  • ..."The simple question that went unasked was "If the strategies are so good, and you're tracking so well against them all, then how come the stock has done so badly, for so long, relative to the market and most peers despite massive buybacks?"..."

    The simple truth is the strategies are too high level to actually track from a Wall Street perspective. And the metrics against them are equally foggy or statistically contrived (give me a bunch of data and I can make it say anything you want - by selecting the points that "prove" my statements). Shareholders are confused or befuddled by execs worth billions so in theory they must know something.

    Institutional investors aren't moving the stock up because they have no faith in consistent execution at Microsoft. Pulling rabbits out of hats is not a valid business model. Our execs have failed to show consistent, repeatable, directly related to strategy and revenue acceleration business process improvements at the company. We have lots of beauracracy - make no mistake - but that is the anti-productivity behavior that will keep the stock price deflated.

    So...our execs are playing to the psychological components that move the stock price with "I'm a billionaire so listen to me" grandstanding and selective data while ignoring the business fundamentals that would in reality make them billionaires all over again. Truly sad and the board of directors needs to own this and fix it.

    By Anonymous Anonymous, at 5:34 PM  

  • "The buyback didn't make the price better."

    It's not a direct relationship, nor one that plays out immediately.

    By Blogger MSFTextrememakeover, at 8:33 AM  

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