Wednesday, April 25, 2007

Show us what you've got

Here we go again - quarterly earnings. Time for current leadership to take a break from providing conflicting messages, empty marketing spin, jealously trash-talking better performing competitors, professing undying confidence in the future while leading the industry in insider selling, etc., and just show us the numbers.

So far, GOOG and AAPL have BLOWN AWAY estimates this quarter. For example, here are AAPL's exceptional results from last night (the stock is currently up >$3+ today, following a $2 gain before the news yesterday):

Apple reported on Wednesday net income for its fiscal second quarter jumped to $770 million, or 87 cents per share, from $410 million, or 47 cents per share. Revenue rose 21 percent to $5.26 billion. The results blew away Apple's own forecast, which tends to be cautious, of 54 cents to 56 cents. Analysts had expected Apple to earn 63 cents per share, on average, on revenue of $5.17 billion, according to Reuters Estimates.

Even perpetual spoiler AMZN managed to beat the street handily. Will MSFT? TBD. PC sales have been strong, and Office sales have reportedly been so too - which should help. But recall that major deferred revenue from last Q will be recognized this Q. While that will skew the numbers higher, it will likely also cause confusion and delay as analysts try to adjust for it and figure out what happened on a normalized basis. Of course, actual earnings are unlikely to materially impact the stock - unless it's a real blowout either way. Instead, as usual, the fate of the latter will rest primarily on what MSFT has to say about guidance for the year - especially given the uncertainty caused by Ballmer's now infamous "some Vista estimates are overly aggressive" doublespeak. Heading into the report, expectations appear to be pretty low. Remember the good 'ol days when the stock ramped heavily into earnings? When the main concern wasn't would they beat, but by how much? Well, those days are long gone. Now, if there's a predominant sentiment it's usually fear. Fear of a miss. Fear of reduced guidance. Fear of some comment that will extinguish whatever spark of investor interest has begun to materialize. There's a huge message there for MSFT's Board of Directors. Are they listening?

Given the low expectations, a meet or slight beat, combined with no change to [previous] guidance, might be sufficient for a relief rally. But coming on the heels of AAPL's upside blowout, that kind of lackluster result could once again raise concerns that MSFT is struggling while some others are hitting on all cylinders. In other words, it might highlight the truth. Which, if you're a fellow long, would be a bad thing. So, hope that they put up something better than that (possible on earnings, doubtful on guidance), or that the market has long since figured out what an under performing mess MSFT is, and already knows that AAPL and others are operating in a different league entirely.

Pre Earnings:

Some preview articles, if you're interested:

I'll provide more commentary post conference call.

Post Results:

A quick review says better than expected. EPS appears to be $.50 vs consensus $.46. Haven't had time to see what's in there, but on the surface it's a decent beat. A whopping $6.9B of buybacks on the Q obviously helped. The important item - guidance for next year - seems to be in tact and even increased slightly (now calling for EPS $1.68-$1.72 on Revenue of $56.5-57.5B, versus consensus EPS of $1.70 on Revenue of $56B). However, guidance for Q4 is down (EPS of $.37-$.39 on revenue of $13.1-$13.4B, versus consensus EPS of $.41 on revenue of $13.4B). Taking a brief look at segment results, Client was strong as expected given the deferred impact from last Q (revenue up 67.3%, profit up 70%). Ditto the Business Division (revenue up 33.8%, profit up 42.2%). Server and Tools notches a slower but still solid Q with revenue up 14.7% and profitability up 31.6%. Online continued to underperform, with revenue up just 10.9% and a huge increase in losses ($200M vs $24M). E&D was weak with a 11.5% decrease in revenue but a 22% reduction in losses (not totally surprising given the decision to hold the line on Xbox pricing versus dropping it to gain share). Looking through the .ppt, Dynamics seems to have had another ~20% growth Q. That's decent but not spectacular given market growth there. Xbox sales of just 500K units on the Q seems weak, but likely helped overall earnings. There are also some seemingly positive references to Vista adoption and premium mix, but I'll wait until I hear the cc before attempting to interpret. The stock is currently up $1.27 in AH. Maybe they should just cancel the cc versus tempting fate :-)

Post Conference Call:

Nothing earth-shattering. Several references to "excellent results" and a general sense that Liddell et al feel they've put up some good numbers - and will continue to. Foreign exchange apparently helped revenue by 2%. OEM premium mix was 71%. That's up 18%, suggesting that Vista is helping there (but a lot of it is the move away from XP MCE XP Home to Vista Home Premium given how crippled Vista Home is). WRT Vista, there was very little specific guidance. Basically, Liddell suggested that the mid single-digit PC growth expected for mature markets is the base line, plus 3 percentage points of emerging market growth/piracy reduction and minus 1-2% for a "difficult" retail comparable. So basically high single digits to low double-digit GAAP revenue growth overall (see slide #21 in the deck if interested).

The apparent reduction in Q4 guidance didn't seem to get much airplay by analysts. I guess everyone was just relieved, and didn't want to spoil the mood :-) Also given a pass in the general euphoria, was the forecast for Online next year which is extremely weak - 5-7% growth vs Q4's 10-15%. Huh? They're expecting to do even worse? Analyst Charles Dibona did question what the plan was now that "the patient had been somewhat stabilized, but even he missed this apparent non-sequitur. I may listen to the cc again later to see if I missed something there (update: a commenter pointed out that I did miss something and was mistakenly looking at the forecast for 07 vs 08 - hence the strikethru. No guidance for Online was given). Finally, if there's a disappointing takeaway from this otherwise better-than-expected call, it's that EPS will only rise slightly ahead of revenue next year. In other words, MSFT plans to keep spending away versus tightening its belt and leveraging the bottom line. If MSFT was a lean, efficient machine, and its investments were visibly paying off, that would all be well and good. But pretty obviously that isn't the case. Until that changes and the company focuses on improving efficiency/effectiveness and accelerating earnings, expect the stock to continue to lag the market. But in the short term, we should maintain at least some of tonight's AH pop following this result.

Update: Some corrections thanks to a commenter. Also, some other reviews here:

Monday, April 23, 2007

Nibblin' on sponge cake

Watchin' the sun bake.

Ah, the opening line from Jimmy Buffett's Margaritaville and the reality I've been living for the past two weeks. Okay, so it wasn't Mexico and the concoctions weren't frozen, but it was tropical and chilled drinks went down just fine! I also took a two-week break from watching the markets and anything even remotely related to Microsoft. Alas, all vacations eventually come to an end. So now that I'm back to the cold, rainy reality of home, I figured I might as well add to my misery and review MSFT developments.

The first thing I noticed was that MSFT lost the bidding war for DoubleClick to Google. I didn't think DoubleClick was worth the originally rumored $2B price tag, so the $3.1B actual makes even less financial sense. Still, it seemed pretty silly of MSFT to pursue a purchase without ensuring that it had the deal locked up or was prepared to outbid any potential rival. But then I read John Battelle who states that MSFT actually did offer to outbid GOOG and got turned down anyway. If correct, that's a big ouch! So MSFT once again loses a visible high-stakes acquisition target to GOOG. Then they compound that embarrassment by whining to government regulators - joined by fellow convicted monopoly AT&T no less. And reading [MSFT general counsel] Brad Smith's comments about the impact of this deal, I'm tempted to buy GOOG. Battelle wraps up with this thought:

The more I think about it, the more the fact that DBCLK went to Google strikes me as a seminal moment in the history of this industry. Microsoft could not win it, despite the cash it was willing to spend. Why?!

I'm not sure how seminal it is - although clearly it's another feather in GOOG's cap. But wrt "why?", I assume because DoubleClick wanted to partner with the clear market leader vs an also-ran - duh. Maybe this helped as well?:

MSFT Board of Directors: are you listening? BTW, if regulators don't stop this deal - which seems likely - I've got to believe that the odds of a YHOO/MSFT hook-up just increased substantially. What other choice does either have?

Thanks to a blog commenter - no doubt one of the ABMers who troll my site (a hyperlink to a negative story with no commentary being the signature trademark) - the next item I noticed was that Goldman Sachs dropped MSFT from its "Americas Conviction Buy" list. Now that MSFT perma-bull and permanently wrong analyst Rick Sherlund is moving on, it appears that his replacements aren't as bullish. Another source provides this quote from GS analyst Sarah Friar:

Product upgrade cycles should provide strong revenue and profit growth in the next 12-plus months. Normally, this would make us view the stock as a must-own. At the same time, these launches may also mark the end of an era, as changing technology and business models seek to diminish Microsoft's hold on the desktop, which in turn significantly depletes the cash cow.

Most of Friar's comments are a rehash of concerns that most investors already know. And sadly, despite dropping them from their elite list, GS still maintained a "buy" recommendation on MSFT. Having been wrong for the past 7 years, an outright "sell" might have at least been a decent contrarian buy indicator :-) Oh, and meanwhile Friar is bullish on Oracle, who's strategy of making accretive acquisitions is paying off where it counts - the bottom line. MSFT Board of Directors: are you listening?

Another item that caught my attention was the ongoing speculation over Vista and whether it's succeeding or failing. You know things are bad when MSFT has to counter claims that Vista has sold just 244 copies in all of China. DELL going back to offering XP on some PCs isn't overly bullish either. But the Seattle PI's Todd Bishop has the best quotes, including this gem from Ballmer:

The adoption of Vista in the corporate market has not been slow. At least not relative to history or my expectation. This is important for people to recognize. Unless we do essentially a service pack, corporations, for good reasons, are notoriously 'slow' to adopt.

So, adoption has not been slow, er...well...just notoriously slow like normal? Um, okay. Ballmer continues:

It's about the speed of past releases, and what we would have anticipated.

Here's a quick translation for those new to MSFT: when Ballmer says "it's about the speed of past releases", that really means "it's trailing past releases by a significant factor but not by so much that they think the SEC could charge them for lying about it". And before some of you take me to task for impugning Ballmer's honesty, let me remind you that it was only about a month ago that MSFT was sending out demonstrably false press releases claiming that Vista was off to a much faster start than XP. Or, you can review his claims of Citigroup deploying 500K copies of Vista when the actual number appears to be 325K. In any event, this entire disinformation campaign which has gone on for months will come to a merciful end on Thursday. At that time, financials and updated guidance are due and there will be no place left for truthiness. In my view, Vista is off to a very slow start. As Lee Pender of the Redmond Channel Partner Online says:

For now, though, Vista has to be a disappointment. Given how long it took to release and how much of a financial boost Microsoft needs from it right now, Vista just isn't building the momentum or gaining the kind of market traction that Redmond would like to see.

Therefore, the only issue that remains is whether - marketing and Ballmer bs aside - MSFT anticipated that in their guidance, or whether they'll be forced to revise downward as a result. MSFT Board of Directors: are you listening?

Another commenter-supplied item from a likely ABMer was this piece claiming that MSFT is "Dead". The author goes on to state that no one is even afraid of MSFT anymore. There are elements of truth to many of the author's points, but the conclusions are overdone. For example, I'm pretty sure GOOG (his MSFT-killer and "most dangerous" company) didn't just overpay for DoubleClick to the tune of some $1B+ because they thought MSFT was dead or not worth being afraid of.

News of Microsoft offering an entire bundle of software for $3 to students and Governments in developing countries also caught my attention. On the one hand, $3 is better than the current nothing. But it's seemingly impossible to ignore the fact that MSFT wouldn't be doing this if not for the growing threat of Open Source alternatives. After all, MSFT has been mostly resigned to the status quo of massive piracy in these countries for some time. So what changed? Why is ongoing anti-piracy education no longer enough? Please don't say it's the incremental revenue at $3 a pop - that's a rounding error for MSFT's financials. So, more likely, it's the concern that w/o that low price tag users in these countries will get their first experience via Linux instead. Is this a wise move then if that's the case? I guess. But at what point are US purchasers going to tire of underwriting the majority of MSFT's revenues while others around the globe pay pennies on the dollar?

From the "I told you so" department - or perhaps the "get the early news late" one - Forbes weighs in on the overall Xbox and H&E business model. Excerpt:

Well, after five years and over $21 billion invested, all they've got to show for it is $5.4 billion of cumulative operating losses, and Xbox 360 doesn't appear to be the silver bullet to turn things around.

Apparently Forbes isn't privy to the Machiavellian underlying strategy of burying Sony (which others have offered up here to rebut my repeated criticisms of the Xbox business model). Go figure. The author goes on:

Why might it be that Microsoft has strayed from the classic "revenues minus expenses equals profits (losses)" disclosure? Perhaps because it doesn't want investors to focus on the fact that more than $21 billion has been invested in a business that has performed so poorly, with unclear prospects for improvement.

Current management being less than forthright about failure? Perhaps even hiding facts via abbreviated financials despite a supposed commitment to "transparency"? Say it ain't so. MSFT Board of Directors: are you listening?

Another item of interest is Mini-MSFT asking why MSFT shareholders continue to be shareholders. Heck of a good question. Going back to the Margaritaville song, that must be the "I don't know the reason, I stayed here all season" line. Maybe we're masochists. Or maybe we think that no management team can go this long without eventually having at least one winning year - though Ballmer et al appear to be focused on being the exception. More likely, it's because we hope that at some point an institutional investor will press for major changes and we'll get a new management team capable of turning MSFT's many market advantages and resources into growth and earnings - versus squandering them. Mini goes on to state that he's unloading his ESPP stock and award grants due to declining confidence in the company's ability to turn things around. That's sad but understandable. And, of course, he's in good company.

Desperate, as usual, for some good MSFT news, I finally managed to find this - just 6 or so pages of GOOG results later:

Take it for what it's worth. Personally, I wouldn't recommend buying MSFT to anyone and haven't for many years. But if you're already in the stock - as I am - then perhaps their perspective is of some value. IMO, Ballmer and the rest of the current leadership team have failed rather miserably and it has been reflected in the stock. That situation won't likely change until they're replaced - and by then it may be too late. If you don't believe me, review this which quotes a recent Barron's study on "CEOs who have top-notch reputations in the financial community and who likely would be missed by investors if they unexpectedly left their jobs." Ballmer doesn't even make the Top 30. MSFT Board of Directors: are you listening? But since we all have a choice in continuing to hold it, I guess I'll leave the last line to Jimmy Buffett:

But I know, it's my own damn fault.