Thursday, August 30, 2007

Wanted: Significant MSFT shareholder with a spine

For some time now, I've been watching MSFT's laughable execution and downward spiral. I'm not talking about revenue, where the near-monopolies have proved strong enough that even this management team haven't been able to screw them up beyond modest growth rates. Or profits, where their anti-Midas touch has had more detrimental impact, but still not enough to throttle gains completely. I'm talking about the now almost institutionalized missed ship dates (the latest btw being Server 2008, which I believe makes for a delay on every major product release this year), largely uninspired products, endless gaffes, and of course investments that only bring losses, to name just a few.

As incredulous as I've been over this performance, I've been even more amazed by MSFT shareholders. While owners of other companies (most with far better track records than Microsoft this decade) have mounted serious campaigns to replace their leadership teams and Boards, MSFT shareholders have been largely silent. Indeed, the nascent pressure that was building for Ballmer's ouster 2-3 years ago has largely dissipated. MSFT shareholders are a binary lot, it seems. They either vote with their feet and sell (as they have for the past 5 years), or continue to hold and suffer in silence. And, of course, there's always the current leadership team telling us how super-fantastic everything is, or soon will be at least, while leading the market in insider selling. I tell you, sometimes it's enough for even me to question whether my perception of the company is accurate. But then I look at the stock price, or drop by Mini-Microsoft, and know that my view and that of the rest of the world is largely simpatico. Still, it's always nice to get corroboration. Which brings me to an article courtesy of David Hunter's Microsoft News Tracker site:

Some excerpts:

In 2017, what and how big will Microsoft's major revenue streams be? Even discounting hindsight, that's a lot harder to answer than the same question ten years ago: As Vista has proven, XP is good enough: that wasn't the case for Windows 95 or NT.


So Microsoft is a huge company with a fuzzy future. In many respects, it's underperforming, if not stalled.

Double check.

The company has huge stockpiles of cash, no debt, an enormous and predictable cash flow – and almost entirely stagnant growth prospects. It's got so much money it can lose tens of billions on a new project like the Xbox, and still keep the thing going. It can take five years to produce an update when its competitors are doing it every six months, and nobody cares. It has one mode of operation, and that's to charge ahead like a stegosaurus: its upper management, plentiful enough by themselves to populate an entire Jurassic landscape, rarely show signs of evolved thinking. When was the last time Microsoft surprised you with an unexpected sparkle of intelligence?

Triple Check, although I strongly disagree with the "almost entirely stagnant growth prospects". At the risk of being overly simplistic, if you find new and innovative ways to save customers money, make them more competitive, or even entertain them, you can sell them more and grow nicely. If you largely sit on your ass and subject them to wave after wave of often marginal upgrades out of some delusional sense of entitlement, you can't. Is the former easy? No. Is it possible and routinely done by others? Yes. Oh, and for me it was sometime in the late 1990's for that question at the end there.

There are huge savings possible by culling management and R&D, neither of whom seem to have the slightest positive effect on sales or products.

Quadruple check, although maybe "slightest" is too strong. More accurate, imo, is that both have had wholly insufficient impact to justify their considerable cost.

Anyway, by now you're getting his drift. Or possibly think he's me, only far more concise and eloquent. He even states the scenario that I've posted here repeatedly:

There is no way that the current state of Microsoft is the answer to any question concerning the sensible use of the resources within the company, and the massive inertia it possesses can only protect it for so long: either outside pressures will overwhelm it, or it'll collapse under the weight of its own contradictions.

Sadly, I continue to fear that collapse (or at least several missed financial quarters) will be the eventual spark for change - and then even more people (employees and shareholders) are going to get hurt, and it may well be too late. But fwiw, the author (Rupert Goodwins) is more optimistic. He thinks a change is on the near-term horizon:

This is the weather for a coup, whether by a posse of external shareholders with inside support or a rebel group of managers with help from the investors. The trigger point isn't far away – we're nearing the end of the multi-year transition period that's seeing Ray Ozzie and Craig Mundie replace Bill Gates. By now, the changes in Microsoft should be visible – but it's not looking that good.

The "rebel group of managers" willing to back away from the SPSA feeding trough long enough to finally do the right thing for the company and shareholders, sounds like a tall order. A "posse of external shareholders" seems a lot more likely, but right now there's no obvious sheriff - or posse. A third option would be a former MSFT manager with external shareholder backing. Someone like Brad Silverberg, for example, who was right about the web when Gates and Ballmer were wrong and is no longer there because of it. But lately he's been praising them. Or maybe he's just laying the groundwork for an impending return :-)

David Hunter notes this concern at the end of his post:

It is certainly possible, but who is going to step forward to lead the charge?

Excellent question. Where is our Eric Jackson, the shareholder who successfully led the charge for YHOO's CEO departure and is now going after Motorola? Where is the person responsible for say, Capital Research & Management Company's 530,043,392 shares held in MSFT? Why isn't he/she front and center raising concerns about their chronically underperforming investment? Or do they have to carry that much MSFT just to mimic the indexes in their funds? What about CalPERS? They're normally not shy about calling out an ineffective management team. Is MSFT somehow the only large cap they don't own a decent chunk of? Does anyone think Gates' own personal investment vehicle, Cascade Investment LLC, would sit idly by through five years of market underperformance and a flat-lined stock? If so, you've obviously forgotten how quickly they made their concerns known to Six Flags management when they were displeased with the latter's execution. So where are all the Cascade-like equivalents that own this underperforming stock and company? Why aren't ANY of them visibly making their concerns known? Surely there's one money-manager out there that has his/her own money at risk, and/or actually believes in their duty to investors to ensure management accountability and performance in the companies in which they invest? Someone with some clout and a backbone? We just need one...



Cramer said Microsoft is "so IBM in 1988, it's frightening ... they think they're a nimble growth company."


"Microsoft, other than aQuantive, feels it's better at everything than anyone," Cramer said. "Maybe it was at one time. But that's a terrible amount of hubris to run a company with."

Tuesday, August 21, 2007

Home runs, base hits, virtual aspirations and actual failure

As shareholders we all want MSFT's "investments" to pay off. The company obviously can't live on just its legacy cash cows forever. New accretive investments offer the potential for not just keeping the company strong, but also [finally] accelerating earnings.

Unfortunately, as per my last post, most haven't over the past decade. Sure, they've taken the up-front cash required by most investments - way more than most in fact. It's that niggling little thing called profit, or shareholder value created, that's proven elusive for the current leadership team. Which is why we now get CFO Liddell belatedly telling us that we shouldn't look for normal internal rates of return from these efforts like at other companies. MSFT "investments", you see, are special. They don't follow normal convention. Instead, they are "winners-take-all" events. MSFT is swinging for the fences; They're not interested in mere base hits. And all those apparent strikeouts so far? Well, they're hoping the game goes into extra innings.

Let's examine how this has worked out in just one area - virtualization. Back in 2003, in a uncharacteristically non-laggard move, MSFT bought the virtualization guts from Connectix. Since that time, they've done what they often do after making an acquisition: buried it in bureaucracy, forced it to be a cog in some massive overall strategic architecture plan, and continued pouring cash into it. The result? According to Trip Chowdhry, senior software analyst at Global Equities Research:

The Redmond, Wash.-based software giant has 'been a total failure when it comes to virtualization'.

Tell us what you really think, Trip. Sadly, that's accurate.

Meanwhile, EMC was busy buying a small software company. When asked about it now, they indicate that their go-in expectations were rather modest; They were just looking for a base hit. That company was VMware, acquired by EMC back in 2004 for $625M. On August 14th, 2007, following an IPO for VMware, EMC's remaining 85.6% stake was worth $16B (even more now btw, with total marketcap approaching $27B). And that's after already receiving $218.5M and $150M from INTC and CSCO respectively for a piece of the action.

In other words, for just $625M, EMC (primarily a hardware vendor) managed to buy a software company - a year after MSFT's entry into the segment - and still generate more shareholder value in just three years than MSFT (the world's largest software company) has generated from all of its investments combined over the last decade, with the possible exception of Server and Tools (although that's predates a decade). Oh, and did I mention that along the way VMware has been profitable (something this and other equivalent MSFT efforts almost never are) AND is the category leader despite MSFT's best efforts to unseat them in what even senior management concede is an increasing strategic area?

BTW, for more on VMware see here:

MSFT is a large company and it's reasonable to assume that some opportunities are too small to be pursued because they won't "move the needle" in a meaningful way. However, the current strategy of eschewing base hits for home runs clearly hasn't worked either. The latter have mostly turned into strikeouts, either clearly or soon-to-be. Meanwhile, a few decent base hits like VMware in MSFT supposed core area of expertise (software) -and a strategic one at that - could have put up numbers meaningful even to a company of its size. And in this case it's not like MSFT wasn't there early and spending equivalent amounts of money to succeed. They simply failed to focus, prioritize and win the game. Apparently it was more important to dream about other possible match-ups in different leagues entirely, and spend $20B+ to field new teams like Xbox, for example, only to now risk "becoming a distant third in the battle for market share in the video game business".

The real shame - and waste - is that the internal virtualization team at MSFT probably contains many members who are just as pissed off and embarrassed by this lackluster performance. It's likely not lost on them that just up the road in Washington State, Parallels is generating more buzz vs VMware than MSFT. But they're likely hamstrung by the stifling bureaucracy that's telling us everything will be better if the game goes into extra innings. Server 2008 will come in to relieve, and brings new virtualization/hypervisor functionality. Well, not right away when Server ships mind you - whenever that ends up being. But 180 days later - or thereabouts. Because...well, you know. And "it'll be great" - or maybe just okay. Because...well, you know. That's what Ballmer said about Vista too and look what happened.

Meanwhile the stock continues to under perform. If you're keeping track, that's now under performance versus all three major indexes on an intraday, 5 day, 10 day, 1 month, 3 month, YTD, 1 year, 3 year, 5 year, and decade to date basis. Go figure.

Update: (Related)

As an aside, at what point can we hope for a management team that rather than cite their ability to come from behind as a badge of honor, will deal with the underlying reasons why they're always late to market - or at least slow out of the gate - and need three generations minimum before being competitive?

Update #2: (Related)


Microsoft is far behind and everybody else, including XenSource, is a speck on the horizon.

Update #3: Some actual good news on the VM front:

Friday, August 10, 2007

Growth play, value play, or just lousy play?

That's a question many are asking wrt MSFT. Before trying to answer it let's establish some basic facts, especially since MSFT's current management often work hard to ignore them when they're unflattering (Warning: Long. If you have a more limited attention span and accept a "fact", you can pretty much skip to the next).

1) Fact: Microsoft stock has performed abysmally over the past 5 years

I know, not exactly "news" if you've held this stock for more than a year or two. Still, given current management's refusal to acknowledge it and Ballmer's recent asinine comment that "a lot has gone very well for shareholders over the past five years", I feel compelled to state and support it.

First, during Ballmer's reign as CEO, more shareholder value has been destroyed than was lost by Worldcom, Enron, Tyco and Lucent shareholders combined.

Second, for those who want to cut him some slack given the market meltdown in 2000/2001, let's look at performance since and relative to other industry players. One of my first posts was a recap of a 2004 presentation by John Connors (then CFO of Microsoft). It showed MS's financial results relative to peers during the period 2001-2004. While there was some merit to that compare, it was undercut by the fact that MSFT, the stock, had under performed not one but all of those entities during that same period - a point I made at the time. Flash forward to 2007, and again management is trying to play the "fundamentals" card because the stock has continued to under perform all of these except Sony (note: this and subsequent compares are dividend excluded and use the recent fiscal year-end as the period close). I included a chart in my last post which showed the past five years versus some of them. Since it's difficult to read, here's a breakdown that is complete and adds some additional peers/market indexes (note: data is for the past 5 fiscal years, %'s are approximate - I eyeballed them from the chart - and don't include dividends):

  • MSFT 8%
  • DELL 10%
  • INTC 22%
  • IBM 43%
  • SPY 52% (S&P tracking stock)
  • QQQQ 80% (NASDAQ tracking stock)
  • NOK 85%
  • ORCL 98%
  • CSCO 100%
  • SAP 119%
  • SNE -3% (SONY)
  • CRM 170% (
  • HPQ 175%
  • YHOO 300%
  • GOOG 380%
  • AAPL 1200%

FYI, the ones in blue are the companies Microsoft originally chose to compare themselves to back in 2004, in what was already a self-serving list. If you add the peers that should have been included then and now - INTC, GOOG, AAPL, CRM, YHOO, the S&P, and NASDAQ - the under performance by MS is that much worse.

In other words, the truth is that things have gone very poorly for shareholders over the past 5+ years by the only measure that ultimately matters - stock performance.

2) Fact: Investors have been more than patient

Ballmer explicitly and implicitly stated at the recent FAM that investors have too short a time frame. He mentioned "three years" and suggested that more patience was required. As seen from the discussion above, three years came and went a long time ago. In fact, all "blue" names above except SNE have now outperformed MSFT over the past ten years (fiscal year-end close, dividends out). Ditto CRM, HPQ, YHOO, GOOG, and AAPL. If anything, investors have been too patient.

3) Fact: Management's statements are at odds with observable facts and the stock's performance

Publicly, management maintains that everything is going fantastically. They do this in many cases regardless of observable conflicting data. For example, "A lot has gone very well for shareholders over the past 5 years", while the stock has grossly under performed most peers and all three major indexes. "Vista is experiencing strong momentum", while the CEO of Acer says "the entire industry is disappointed" and MSFT substantially ratchets back previously forecast penetration rates for this year. "Microsoft has revamped its software development process", as yet another product - Office for Mac, this time - slips. Losing another ~$1.9B on Xbox is "actually quite different" from a unsuccessful year, and after investing over $20B since 2001 to generate $6B in cumulative losses with still no end in sight, "We're in a very good position on the fundamentals of that business". The inability to show normal returns from new investments within the "several year" time frames originally guided for, becomes "most of these decisions are not 15 percent IRRs that become 16 or 14. Most of them are winner-takes-all or extremely high net present value decisions if we are successful in the marketplace that we make.". Finally, $100B in buybacks and below-market dividends - over half of which went merely to reduce dilution caused by paying enormous sums to insiders - is "money returned to shareholders".

But let's pretend we're as stupid and gullible as management apparently thinks we are, and ask:

Okay, if the company's current 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 and despite massive buybacks?

That's one they're seemingly unable or unprepared to answer. Indeed, they want to ignore the stock completely - as they have for most years this decade. Or, as Liddell did at the recent FAM, suddenly agree the stock is important and claim success on the year, meanwhile ignore the fact that it came primarily as a rebound from a major sell off following their world-class screw-up the year previously. When challenged on that obvious lie of omission, they fall back to a two-year compare w/o noting that even that return represented under performance versus all three major indexes.

Management want to fashion this debate as our - and the market's - lack of patience, versus their failure of leadership, strategy and execution. Well, at least publicly. Privately, of course, they lead the entire market in insider selling. They also ensured that their bonuses are no longer based on long-term options (that only had value if the stock rose), but rather on low-risk grants that now get handed out annually versus the previous three years (and vest from there). I guess patience is a one-way street.

John Dvorak sums up this conflict nicely here:

Especially in this passage and the several that follow it:

Meanwhile, the company has to struggle with the reality that it cannot really do much right. This has to drive its people crazy. Okay, maybe not crazy, since boatloads of money are still flowing in, but it must be that because they know they can't do anything right.What I'm saying may be a stretch because it is possible — in some perverse dimension — that some people at Microsoft actually think they are doing things right.

4) Fact: The leadership team's actual track record of investments is decidedly mixed, if not in fact poor.

Again, let's suspend our mounting disbelief and ignore the observable conflicting data points. Overall, management's claim is that they are "investing for the future". The implication being that other companies aren't. Could that be it? Is Microsoft taking a long-term approach while others merely optimize for an often quarterly-focused market? Possible. In fact, it was this long-term approach that attracted me to the stock and kept me in it in the first place. Unfortunately, MSFT's rather anemic results (the slowest growth in their history as a public company two years ago) while others deliver superior revenue and earnings growth year over year (GOOG and AAPL in particular) - and MSFT desperately tries to catch up and emulate them - makes that assertion somewhat strained. It also belies the fact that all the massive investment done earlier, the so-called "emerging bets", were originally justified as being the "next sources of growth". Sadly, while they have helped revenue, collectively they have only detracted from earnings. Which is why as badly as MSFT stock has performed this decade, the best analysts in the business can only justify a 15%-20% upside from the recent - though now a memory - $30 level based on current guidance.

Rather than concentrate on fixing that, in part by better focusing, cutting expenses, and driving the bottom line, management denies any problems and is making new "investments". Again, these are being sold as the future growth areas for MSFT. In reality, they represent the areas that others pursued and proved to be more successful, sooner (to the point where some now potentially threaten MSFT's very future), while management was busy focusing on their still unproven "emerging bets". Leadership shrugs off this criticism even though they're at least guilty of badly blowing expected payoff time frames (remember Bach's "we don't invest in areas to go years w/o making a profit?", when asked about Xbox in 2001?). Instead, they point to Server and Tools as proof of their investing chops: "Go back 10 years and think about the Server and Tools business, which wasn't in existence to any great extent there, which is now one of our fundamentally biggest and most valuable business". Server and Tools is a huge success story. But what about Set-top, IPTV and MSN - all begun around the same time and representing some $15-20B of investment? Or, for a more recent example, how about that stupendous display of fiscal irresponsibility and lack of business judgement known as Xbox?

When "investments" don't make returns and are needed just to defend what you've got, they're called increased operating expenses and shrinking margins. Again, current management want to ignore the adverse impact on overall margins, even comically telling analysts that they should separate the company into core versus new.

5) Fact: Management is arguing with the market and results, and shareholders are paying the freight for that hubris and failure

For the past 5 years or so, Microsoft's leadership has been waging a battle with the market that they're still a growth stock and thus deserve a growth stock multiple (can spend and hire as they please, etc.). For most of that time, MSFT's results have made that statement laughable, which is why the P/E ratio has been deflating (finding support around 20 these past few years) and shareholders have seen their equity destroyed. Now that revenue growth is back to double digits, management is once again beating the drums that they're a growth play. Since the corresponding earnings acceleration isn't there, they keep suggesting that it's "just a matter of time" - well, once they get past the current er... "investment mode". Unfortunately, the market has seen this movie before. They know MSFT has been in investment mode for most of the past decade and yet their business - and most of their profit - is still primarily dependent on PC sales, just like it always was. Only now, due to emerging markets, piracy, competition, uninspired products like Vista, etc, MSFT can rarely even match that overall growth rate.

Many investors would like to see MSFT admit that it's in a mature PC market and that its investments haven't radically altered that. While that doesn't mean they expect the company to give up on new ventures completely, it does mean they want to see the scope of their ambitions decreased and costs come down.

Brier Dudley has a good piece where Goldman analyst Sara Friar (who replaced MSFT perma-bull and perpetually wrong since 2001 Rick Sherlund) lays out that argument:

One of the biggest frustrations I hear out there is why, in what has become a more mature industry, why are we still running the company like it's a start up or a young high-growth company because it's not.

That means in my mind you mature up the capital structure, take on some debt — you lower your cost of capital — you also could do a really substantial stock repurchase.

Personally, while I believe that with the right leadership (strategies, focus, products, investments, execution, etc.), Microsoft could be a lot more successful, grow faster and deliver better revenue and earnings acceleration, it seems clear that the current leadership team has been unable to provide that despite an extensive period in which to demonstrate their ability. At the same time, for those who disagree with me and think MSFT is doomed to being a value play (if anything), it's clear that the management team is totally unprepared to run the company in that manner. In other words, whether you think the company is a "growth" play or a "value" play, it appears we have the wrong management team. Which is why MSFT has largely been shunned by both "growth" and "value" constituencies and the stock has been moribund.

6) Fact: External shareholders are the majority owners of this company

While Gates, Ballmer, and several other insiders (not to mention employees) hold a large amount of shares, the vast majority of MSFT - 80%+ - is held by external shareholders. So it's actually our company and the management team is meant to be working for us. Although listening to them, you get the sense that this is reversed and we're auditioning for the role of bagholder.


Like most investors, you presumably have no interest in being a bagholder, nor did you take a vow of poverty or volunteer to lose money in order to ensure the future of Gates'/Ballmer's legacy. While they might have many reasons for doing the latter (now that they, their kids, their kids kids, etc. are taken care of regardless), I assume you are invested here to make a reasonable return versus competing options. If so, you have three choices: 1) Sell. 2) Continue to be patient and hope the management team eventually delivers the kind of results that will drive the stock. 3) Call for change.

If you've ruled out #1, then the obvious choice imo is #3. It's time for shareholders to understand that the problem is management's failure, not our lack of patience. Ample patience has been furnished already. Patience hasn't worked because leadership, strategies, priorities, execution, and accountability are flawed. The passage of time alone isn't going to fix that. Ask yourself this, is the company stronger now than when Ballmer took over? More respected by customers? More feared by competitors? Do the "trains run on time" better? Have the massively expensive "emerging bets" paid off? Are you more confident in the company's competitiveness and future?

For me, the answer to all of the above is a resounding "No". While there has been progress in some areas, the overall result in each category is a negative, and the stock reflects it. Therefore, Ballmer needs to go. A good deal of the senior management team who have contributed to this failure of strategy and execution, while feathering their own nests, also need to go. The Board, who in apparent contravention of their fiduciary responsibility have sat by while the company's execution has become a punch line and shareholders have been royally screwed over, need to join them. Then maybe, just maybe, this company can get back to basics, execute exceptionally well on that, and rebuild the customer enthusiasm and market confidence in management and their strategy/execution that imo has clearly been lost under the current regime. Until then, as it has for more than five years now, MSFT will remain neither a growth play or a value play - just a lousy play.

Update: Chart update (see previous discussion here):