Wednesday, February 28, 2007

Limbo, limbo, like kimbo

A limbo is, among other things, a West Indian dance in which the dancers keep bending over backward and passing under a pole that is lowered slightly each time. Substituting the stock for the pole (or bending over for that matter), that sounds remarkably like the fate of MSFT shareholders. Now, if you didn't do too well on your college SAT here's your chance to redeem yourself. Given the series: $31-$30-$29-$28, what might logically come next? Okay, maybe that's not quite SAT material - but you get the drift.

So, another day and another MSFT selloff - nothing surprising there. Far more ominous, was the fact that the market rolled over with it, although a computer glitch may have exacerbated things(thankfully not a MSFT one for once). At this point, it's unclear whether any of the MSFT stock action can be blamed on that (it apparently impacted the DOW 30 of which MSFT is a member). Nevertheless, MSFT managed to do worse than every tech stock I track with the exception of AAPL - and that's on top of the severe selloff YTD. While I'd like to be more constructive, there's no denying that MSFT's chart is now completely broken technically and screaming "Sell". A full 1/3 retracement of the June '06 to Jan '07 run has been completed and yet the stock is still showing no signs of firming. So if the market continues rolling over, odds favor MSFT eventually testing (and likely dropping) the 200 day moving average which is currently sitting at $26.78. If things get really bad, expect a full 2/3 retracement to ~$24.74. But hey, look on the bright side: by then, the dividend yield will be closer to market.

Reviewing the company-specific news for hints as to why the stock performed so poorly, there wasn't much out there. Sure, having been warned that Vista expectations were too aggressive, the market is being its usual bi-polar self and now factoring in an Edsel-class failure (or is that - shudder - Windows Me-class?). That seems overstated, but there are some pretty horrible reviews out there including ones where people are going back to XP from Vista. Ouch! A lot of that appears to be teething issues with 3rd party drivers and it's still fairly early days in that regard. Also, I haven't used the product yet so will withhold judgement. However, I think it's fair to say that Vista isn't currently the breakout success that we might have hoped for when Ballmer said "It'll be great, bet on it". On the other hand, maybe he meant just a small bet - like five bucks between you and a pal - versus say, buying or continuing to hold MSFT stock.

Looking around for other possible catalysts, some journalists were rehashing the news that broke last week about GOOG apps and the threat to Office. Yawn! However, if you were an investor who just got back from a quick trip to Paradise Island, I'm sure the news didn't make you want to rush out and buy MSFT. As an aside, the fact that MSFT didn't take a direct $1-2 hit on this news - and GOOG rally $10-$20 - is interesting. That wouldn't have been the case even six months ago. Unfortunately, that's likely a reflection of the massive run GOOG shareholders have already enjoyed versus any renewed confidence in MSFT.

That left the only real company-specific news being Ray Ozzie's presentation today at the Goldman Sachs Technology Investment Symposium. I had originally intended to cover that as a post topic on its own, but quite frankly I didn't hear a lot that was new or interesting. If this was meant to be MSFT's Software+Service strategy equivalent of the Sermon on the Mount, it fell short - and that was despite [perpetually wrong on MSFT] analyst Rick Shurland's repeated attempts to throw Ray a slow pitch in hopes he would knock one out of the park. He didn't. It's not that I can fault anything Ray said per se, it was all reasonable enough. It's just that he didn't say much that was concrete wrt plans or timeframes and it all sounded pretty conceptual at this stage - which is concerning if you were hoping this was the Extreme Makeover "reveal" versus a status update on the state of the industry. Finally, his delivery was almost as coma-inducing as Gates - which didn't help. I have to confess that I was expecting more from Ray, and maybe others were as well. Plus, comments like GOOG giving MSFT a "wake-up call" or:

There is a level of data center and infrastructure that we continue to need to build, he said. This is just going to be a continuous investment.

is hardly stock Viagra, especially when folks look at the fact that GOOG actually makes money on this "continuous investment" effort whereas MSFT doesn't - at least so far.

So, on the margin, maybe that was enough to explain the stock's poor relative showing on the day. Or maybe not. Regardless, the action doesn't bode well for shareholders.

Update: Eweek's pre-conference view on the 10 questions Ray should have answered:

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:

Friday, February 16, 2007

I'll gladly pay you Tuesday for a hamburger today

Wimpy talking to Popeye? No, although the wimpy part has some applicability, and there is a certain undeniable resemblance if you remove the hat and add some glasses. Actually, I'm talking about the message that our fearless CEO (and CFO, although he spent most of the session polishing his Marcel Marseau impression) delivered to Wall St. analysts today. If interested, here's a link to the webcast. And while Popeye famously said "Frien's is the mos' importink thing on eart', neither Steve nor Chris had many friends in attendance. Instead they faced analysts, who were wondering why exactly they should shell out for that hamburger today given that MSFT's post-'00 record of delivering "Tuesday's" promised payment via earnings acceleration has proved to be as elusive as finding WMD in Iraq.

Needless to say, analysts - like long-suffering shareholders - walked away without a satisfactory answer. And while my pre-webcast choice for advance-prediction sweepstakes winner was analyst Brent Hill:

Wednesday also saw a note from Citigroup analyst Brent Thill raining on the parade, with Thill writing that the Thursday event "will be nothing more than a cheerleading session around Vista/Office 2007," with no substantial plans or expectations will be announced.

It turns out that even he was too optimistic since there wasn't much Vista/Office cheerleading either. In fact, if you missed the webcast but pulled up the MSFT quote AH and thought "huh?", in large part that's a reaction to Ballmer using this opportunity to tell analysts they were being "too bullish" for Vista sales in FY '08 - but I'll come back to that later and provide more detail.

So what did analysts get? Well, after warming up the room with a joke comparing last year's staff infection in his foot to the infection that befell the stock around the same time (ah, what leadership, judgement and maturity), he moved on to more weighty matters. For example, there was a discussion of the 5 "pillars" for MSFT's continued success (or future trouble if handled poorly):

  1. People
  2. Innovation (well, not that kind necessarily, but you know)
  3. Investing Broadly
  4. Live transformation
  5. Long-term oriented

I won't bore you with the details, although they were good for some comic relief. For instance, while describing the perils of investing too narrowly ("one-trick pony" - read GOOG, though that was left unstated, of course) or too broadly, Ballmer noted that:

Some companies try to do too much, invest too broadly in too many things for too many people and not doing any of them very well.

Hmm...who does that sound like? It got funnier when he later said that MSFT's approach was the "broadest in the marketplace". Er, Steve, could you reconcile your first comment with your second please? Thx. It happened again on #5 - long-term oriented - when after citing IBM as an example of someone who didn't persist when they should have (routers, PCs, etc.), he explained the problem of being too long-term:

Some are too persistent, don't get accountability and wind up in some sense actually hurting shareholder value by staying with things too long.

My bet on the company that every analyst in the room was thinking for that example? MSFT.

Ballmer then dropped the bomb shell which resulted in tonight's AH selloff: analysts estimates for Vista sales in '08 are too aggressive. Note to MSFT's absentee Board of Directors: when your CEO and CFO address the financial community, it's meant to be a positive catalyst for the stock. Perhaps that should be your first clue that all is not well? Anyway, getting back to it, what Ballmer really said is that "some" estimates were too high. In the Q&A later, after a ridiculous game of cat-and-mouse, he further clarified it as primarily on the top line with "no huge disconnect" on the bottom line. That didn't halt the initial negative AH stock reaction, and it won't halt the headline media reports or tomorrow's likely market action. Nevertheless, it is a significant distinction. Ballmer's main point was that expected Windows growth in '08 should be just a little better than PC growth rates in the developed world (not up to 2X that, as some analysts were apparently predicting - fwiw, none that I've seen, but there you go). He further stated that the bullishness being reflected in MSFT stock but not other PC-related stocks didn't make sense (which sounded distressingly like a "Sell" recommendation), and that a new version of Windows was "primarily a chance to sustain the revenue we have" (I thought I actually heard the stock drop on that one in real-time, but perhaps it was a delayed reaction to his earlier statement that margins moving forward would - at best - stay the same). BTW, there was some good news in this section and that was that MSFT is going to hold the line on spending by and large (and subject to change). As some analysts, like Goldman's Rick Sherlund, had been speculating about another major increase in Op Ex, this should do something to mitigate the downside fallout from the Vista news.

Minutes ~20-41 passed with me sticking toothpicks in my eyelids to try and keep them open. Given that this was the section where Ballmer laid out his 9 high-visibility areas of future growth (as well as 6 less-certain ones), you'd think I would have been captivated. I wasn't. If you're interested, Mary Jo Foley has a good write up here. Alternatively, if you want the condensed version, it's primarily "milk the existing cash cows in the installed base". The list does raise some sobering points though, not the least of which being that after decades of investments in emerging businesses and $10B's spent, the top 5 areas of perceived future high-visibility growth are all dependant on the legacy cash cows. For example, after an unbelievable $5B of losses to date, Xbox is ranked at just #7. Sorry Steve, explain to me again why this was "one of the greatest creations of shareholder value ever"?

The 6 less-certain areas of growth didn't yield much of interest either. Although again, its sobering to see that the beleaguered ZUNE (which recently saw its VP leave to spend "more time with his family") is ranked ahead of IPTV, despite more than a decade of investment in the latter (which, if I recall correctly, included ~$10B in write-offs alone attributable to a failed strategy of telecom/cable ownership stakes). Hmm...either someone's hoping for a stellar turnaround in ZUNE, or that already "small amount" that Ballmer said was going to turn into a lot of money when multiplied by every TV on earth, just got even smaller. One thing that was new is the elevated focus on healthcare. Ballmer now sees this as a good market, which may experience an "explosion" in IT. I guess that explains why say, Oracle's Larry Ellison was looking at potential acquisition targets that included Cerner just four short YEARS ago. And some people think MSFT is slow on the uptake. :-) Kidding aside, this focus makes sense and is long overdue.

About 42 minutes in I woke up again, salivating like a Pavlovian dog hearing its bell. That's because the discussion had turned to future growth versus the competition and what investments MSFT has to make in order to keep up with "the speed and rate of the fastest growing companies in our industry" (AAPL, GOOG, CRM being the examples cited). Huh? Er, Steve, when's that going to start far less go into sustainment mode? I guess he's talking about the really long-term future again - as in Buck Rogers. He never really addressed that apparent disconnect, but I suspect it's a combination of a longer-term view and the oft-used "we need to maintain our share of the industry's overall profit" argument. Of course, the market doesn't really care how MSFT does relative to the entire industry per se, but rather how it does relative to itself and major competitors (which, in most cases, are competing for the same investor $). All that aside, the disappointing aspect here (and in the presentation generally) was the continued failure of current MSFT leadership to deal head-on with the track record of existing emerging business "bets" that collectively are still unprofitable despite massive $ invested for (in some cases) decades, while simultaneously making the case for doing even more. This imo says it best:

Microsoft has always held the view that if they invested enough money and maintained enough persistence they would eventually be successful,'' said Ursillo of Loomis, Sayles. The track record on that approach is mixed at best.

Okay, I know I'm running long and mercifully we're at the final Q&A. Sandford Bernstein's Charlie Dibona came through (as always) with tough questions on the "Live transformation" and related investment given the non-financial metrics going "sideways to south". Liddell, not one to miss a beat, said "at least you're consistent, so I knew that question was coming" - and then proceeded to avoid actually answering it. Earth to Liddell: do you really think this was on just Charlie's mind? If not, might it have been an idea to come prepared to answer it? Anyway, suffice to say that the only "transformation" occurring after that one was MSFT-holders turning into ex-holders in the AH market.

Another good exchange, was when an unnamed MSFT investor asked about why long term investments to date hadn't yielded more success especially in Search/Advertising (go figure), why MSFT wasn't doing something more on the branding side to combat Apple's ads, and whether MSFT was getting maximum bang for its R&D $ vs smaller rivals like who spend far less but can still land large accounts like DELL and CSCO. Ballmer debated the Search and CRM ones, saying they'd done quite well in his view given a later entry. Er, who's fault was that Steve? On the Apple one, he gave a semi-compelling answer that the $200M or so required to combat it didn't make great financial sense when viewed against the likely unit sale pick-up. While explaining himself, he hammered Apple's worldwide lack of marketshare pretty heavily (which should get the MAC zealots and media riled by tomorrow), and seemingly couldn't make up his mind on whether they had or hadn't grown marketshare (at first saying they "really hadn't", and then later explaining that the reason they "had" was the lack of competitive high-end Windows-based laptops - which in his opinion will be addressed shortly).

So that's it. Could it have been worse? Yes. Could it have been better? Unquestionably. Is the stock going to take a hit? Probably. Has the fundamental outlook changed that much? Not really. Could some of this be MSFT's normal talking down of expectations so they can beat them later by a penny or two? Possibly - although the seemingly definitive statement that current operating margins are as good as it gets, could cause some long-term major holders to seriously reevaluate their positions.

Finally, what can I say about Ballmer? Beyond questioning, as I have, what content was included while leaving major issues - like investment track record to date - largely unaddressed, I have a real problem with his tone and attitude. The word that comes to mind is flippant. I'm sure that's not his intention, but it nonetheless seems to be the result. You get almost no sense that this is the CEO of a publicly-traded company who is accountable to his Board and shareholders. There's almost an underlying sub-text that screams "we're going to do what we're going to do, it's going to take as long as it takes, the stock can do whatever it's going to do in the meantime, and if you don't like it, tough". If MSFT's past track-record of investment -or more recent record of execution - were stellar, this kind of focus and long-term approach might actually be admirable. But in light of the BIG unresolved question marks surrounding the former - and embarrassing realities of the latter - it comes across as tone deaf, out of touch, and even reckless. Bottom line, putting aside the larger question of Ballmer's overall suitability for CEO and obvious failure to drive the stock on his watch, there's a reason the stock sells off virtually every time that he talks to financial people. So what's the "first rule of holes" again? Oh right, when you find yourself in one, stop digging.

Update: The stock is tanking as expected. So high fives all around to the team in Redmond for accomplishing your apparent go-in objective for yesterday's meeting. BTW, why do you appear to actually favor a permanently broken/range-bound state for the stock again? Anyway, here's a quick round up of some representative coverage:

Update #2: Gotta love the quote in this one - and from a company with an "investment banking relationship" with MSFT no less (or maybe that explains the attempt at damage control):

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.

A "poor job of communicating"? Steve? Tell me it isn't so! But okay Jason, where's the harm? Oh, a one-day $7B destruction of shareholder value so far? Well hey, everybody can have an off-day. [cue Daniel Pewter's "You had a bad day..."]

Thursday, February 08, 2007

Paddles, CLEAR! ...............THUMP!

That about covers it - stock cardiac arrest. Having seen this movie so many times before over the past 5 years, I'm frankly too disgusted to post much more. And where are Ballmer or Liddell during this latest meltdown? Are they responding to the negative Barron's article credited with the most recent selloff? Nope. Are they addressing the seemingly endless barrage of negative Vista coverage and reviews - including many from sources you'd expect to be sympathetic to PCs and MSFT? Nope. I mean, even with a $500M launch, you just can't buy publicity like this, or this, or this, or this, or this, or - well, you get the picture. Are they putting any public pressure on Apple to get off their asses and get iTunes or indeed ANY of Apple's software Vista-ready in a timely manner? Nope. Are they reaffirming Vista sales in light of numerous articles in the media talking about the lack of interest? Nope. Are they doing anything to reverse the negative perception and concern caused by stories like this, that are making their way throughout the market and the blogospehere? Nope. Why not? Well, apparently they're too busy running the business so badly that all this is the norm rather than the exception.

Will the stock likely bounce short-term? Sure, it's way oversold. Once that's over, will there be any respite from the massive market-lagging performance we've seen for most of the past 5 years without major changes? Absolutely not. Message to MSFT's Board: when do you folks plan on doing your job on behalf of shareholders and making some tough decisions to finally reverse this comedy of errors and continued downward spiral? Keep doing nothing, and maybe this scenario might not be so laughable after all...

Update: Paul Kedrosky does some historical analysis on MSFT stock following major Windows launches: