Growth play, value play, or just lousy play?
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% (Salesforce.com)
- 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):