Wednesday, October 31, 2007

What a difference a week makes

A week ago, MSFT could do no right. Now, following the recent strong quarterlies, MSFT can seemingly do no wrong - or at least the market is prepared to overlook it. Vista still not tracking well and actually slowing? Yawn. Just give it more time. Higher recognition rates dramatically helped client performance last quarter? Sure, but they'll find some more revenue later. Currency gain last Q equal to much of the percentage increase in revenue and earnings guidance for the year? Well duh, but someone might as well benefit from the ever-declining US peso. Insiders selling with abandon again, including ex-President and current Director Shirley who unloaded 500K shares or 25% of his entire position? Hey, a guy's gotta live. Plus, $17.5M doesn't buy what it once did. Apple sells 2M copies of Leopard in the first weekend of availability (~10% of all capable machines)? Not to worry, Mac fans are just zealots. US Antitrust oversight of MSFT might get extended another 5 years? Oh well, legal needed something to do anyway now that lawsuits are decreasing.

Even competitors are helping out with some uncharacteristic missteps; AAPL having some fairly significant - not to mention embarrassing - teething problems with Leopard; GOOG suffering brain-drain and flailing a bit trying to check the growth and popularity of Facebook; Linux growth beginning to slow as the initial migration from proprietary UNIX starts to abate. Not to be left out, mainstream media is jumping on board too. For example, Joe Wilcox writing about the AAPL/MSFT double standard (funny stuff, especially since as a supposedly neutral [at least] MSFT observer he has been among the worst offenders) and ZDNet asking "Can't we give MSFT some props?". [BTW, have no fear. Yours truly isn't about to drink the Kool-Aid completely just yet].

And with that, the stock continues to act more like a Chinese IPO. Okay... maybe I'm pushing it a bit there. But it has made a pretty good dent in the past 5 years of underperformance (now ahead of the NAS over 1 year, still behind over 3). I tell you, if it wasn't for the fact that the sun keeps rising each morning and setting each evening, I'd question whether I was dreaming. If MSFT now starts hitting ship dates consistently, I'll be forced to conclude that I've finally wigged out or entered the Twilight Zone.

Of course, the (more likely) reality is that MSFT wasn't as bad as it seemed a week ago, nor as good as it seems now. The problems that were there before are still there, and much of this [stock] move is simply catch up. For example, even with the recent jump, MSFT still trails the industry average P/E. Plus, the shattering of the 5 year trading range likely attracted some short-term technical buyers - and they'll unwind their trades and take their profits as quickly as they put them on. Still, the high volume that has characterized this move suggests that institutions are doing some serious buying as well. And they don't normally do that unless they expect several good quarters ahead. That said, a decent pullback would seem like a foregone conclusion and even healthy, whereas a continued run without consolidation is risky long term. Today, we didn't end on the high while the Nasdaq did. So perhaps that correction is coming. We'll see (although it's up in AH).

Getting back to the company, I hope the recent stock run is viewed in context internally, not used to excuse continued inaction or otherwise ignore the many areas that still need attention. In particular, I hope someone sees the wisdom inherent in this statement, made recently by YHOO's Jerry Yang [bolding mine]:

In an acknowledgement of the famous "peanut butter" memo, in which one Yahoo executive accused the company of spreading itself too thinly, Yang admitted: "We have taken this idea that we can do two or three things well and not a thousand little things. It probably means we won't focus on a bunch of other stuff. We are in that process of identifying what makes it and what doesn't make it."

But for now, like most shareholders, I'm enjoying the ride and hoping it's the beginning of a more positive process versus just an event.

FWIW: Some other articles I've been reading:

Also, a useful earnings table that I came across:

Thursday, October 25, 2007

Q1/08 Earnings

Pre Results:

Some sample commentary heading into earnings:

The stock is having a very good day and setting highs that haven't been seen since 2002. With expectations running so high there's growing risk for disappointment. Let's hope MSFT can deliver for a change. We'll find out shortly...

[OT: BTW, for those who are interested, I think the Facebook deal is an okay one. No, Facebook isn't worth $15B by any stretch of the imagination. And no, the incremental advertising that MSFT is likely to recoup from the deal isn't worth the $240M either, especially given likely revenue-share concessions (all management bs to the contrary). So while there's a risk that this further extends MSFT's track record of money-losing investments, in this case I think you have to call it a reasonable one. Why? Because even MSFT should be able to recover half that money in incremental advertising. The 1.6% equity stake will be worth something. They get a stronger seat at the table for one of the fastest growing application platforms on the web (a huge opportunity that was also a potential threat). They send a message that they're serious (which should result in some spin-off benefits with other potential advertisers). And finally, losing Facebook would have been a huge blow to their already struggling advertising ambitions (not to mention easily shaving $240M off MSFT's marketcap). So let's call it: Competition 100: Ballmer 1. But now he's got momentum... :-)]


Wall Street was looking for $12.57B in revenue and EPS of 39 cents a share. Microsoft had guided for revenue of $12.4B to $12.6B, with EPS of 38-40 cents. FirstCall is reporting actual of $13.76B and EPS of .45 cents a share. Wow! Still waiting on confirmation via MSFT...

Confirmed: FirstCall got it right. It's a much-needed blowout:

(More after I review the actual earnings release and listen to the conference call.)

Post results and conference call:

Okay, that's done. Other key positives:

  • Fastest Q1 revenue growth since 1999.
  • Operating income at 30% exceeded revenue increase of 27%.
  • Operating margin up ~2 points to 43%.
  • As seen above, every business grew double-digits.
  • Client growth exceeded overall PC growth for a change(primarily due to piracy reduction, especially in fast-growing emerging markets).
  • "The OEM Premium Mix increased 16 percentage points to 75% driven by increased consumer premium mix".
  • Server & Tools continued to lead in bottom line leverage (16% revenue growth but ~25% earnings growth).
  • E&D managed their second ever profitable Q (only $5.8B more to go and they can start generating a net profit lifetime-to-date).
  • Q2 guidance raised to $15.6B - $16.1B and EPS of .44-.46 versus consensus $15.64B and EPS of .44.
  • Full year guidance raised to $58.8B-$59.7B and EPS of $1.78-$1.81 versus consensus of $57.42B and EPS of $1.73.


  • Limited color on specific Vista adoption. Liddell says 85M units sold, or roughly 2x XP over the same timeframe. But that ignores the extended [pre-release] period during which many XP sales qualified for Vista upgrades. It's also units on a [now] much larger base, not relative adoption rate (which was the original goal). Lots of comments about "still early days" and management is comfortable with uptake (as incredulous as that sounds). Also, some proxies like overall growth rates and contract renewals - which are suggestive that Vista is having a positive impact and large-scale deployments may be nearing, but a step removed from hard data like marketshare and/or specific customer references.
  • Online lost even more money (along with share). Not a huge surprise, and a $58M chunk is AQNT-related. Half of MSFT's overall $3.2B-$3.3B in capex this year will get spent in this one division. OSB revenue growth net of AQNT was just 10% (includes expected access business declines). Advertising revenue itself did better - up 25%, in line with expectations. But that's down from last Q's 33%, and way behind GOOG.
  • Operating margins for the rest of year will be lower than Q1 (could be some sandbagging there, but AQNT will apparently detract some $200M from operating earnings).
  • E&D growth guidance for Q2 of -8% to flat. Blaming it on earlier Q1 ramp, but something seems odd there.
  • Unearned on the Balance Sheet decreased ~$1B vs Q4 (recognition also increased ~$1B vs year ago).
  • Common stock repurchases decreased ($2,930B versus $7,683B).
  • See increased risk of an economic slowdown.

Says CFO Liddell:

It was just a very clean quarter, outstanding financial results.

Yes it was. What a refreshing change.

Kudos to all.

BTW, MSFT traded as high as $36.02 in AH. Currently at $35.60. Nice! Lot's of open gaps on the stock chart though, which is a concern. However, if it can hold above $32 in the weeks to come, then maybe this five-year trading range is finally over.


Update: Made a few revisions/clarifications after listening to the cc again.

Update #2: A nice summary of analyst's reactions this morning following last night's results:

Update #3 (10/29/07):

Hmm...that didn't take long. Finally get a pop in the stock and Director Jon Shirley sells 500K shares - 25% of his entire remaining stake. You can never say why an exec is selling for sure, but not exactly bullish on the surface. Johnson also unloads a chunk, albeit a much smaller % of total held.

Saturday, October 20, 2007

What if Microsoft wasn't a screwup?

I had coffee with a friend last week who is ex-MSFT. He follows my blog and asked why I hadn't posted recently. I told him that I'd actually penned three different posts but decided not to publish any of them.

The first touched on Vista's challenges and the growing threat from AAPL (short version: Vista has stumbled badly. Forget the original 2X the rate of Windows XP goal, it's barely tracking it - a damning indictment after 5 years of development and some $5B spent. Also, AAPL is gaining serious momentum - verifiably as well as anecdotally. If MSFT continues to do next to nothing about it, they risk losing not just more marketshare, but possibly OEM loyalty). The second reviewed Ballmer's latest plan to "transform" MSFT (the future isn't in plastic, Benjamin Braddock, it's in advertising. Hmm.. I wonder how he twigged to that one? BTW, is that the 9th or 10th transformation since Ballmer took over? I'm losing track.). Finally, I did one on the eternal bad news story: the stock. In particular, some recent Ballmerbabble - when he wasn't busy making more idle patent threats against Linux:

Mr Ballmer says that the sluggishness is in part the result of overly optimistic Wall Street targets - misguided calculations by “all these expensive, well-meaning financial types” - and in part a function of Microsoft being a technology company subject to more risk than a “bricks and mortar business, like Tesco”.

("Overly optimistic Wall Street targets"? "Being a technology company"? Sure, Steve. Um, how come that hasn't affected say, AAPL? Or HPQ?, or SAP?, or INTC?, or ORCL?, or IBM?, or... well, you get the picture.)

BTW, in the second one Ballmer said about advertising:

“It gives us the chance to surprise shareholders,”

A simpler way to "surprise shareholders" would be to concentrate on doing what he/MSFT already chose to do, only doing it well. Let's start with the basics. Like, say, understanding customer's needs well enough to ensure you have designed a compelling product, then actually shipping any [major] one on time, doing a great job of marketing it, and - this is key - make a profit. Combine that with some sanity wrt headcount increases (especially in the US), and maybe consensus EPS estimates might look more like this, rather than like this. Investors might even award a PE premium to market, versus the current discount.

Anyhoo... despite spending several hours writing those three posts, I didn't bother hitting the "Publish" button in Windows Live Writer (an excellent product btw). Why? Because frankly there was nothing much new there. Sure, the specific examples were current. But the basic underlying themes have been discussed here and elsewhere ad nauseam. And while it would be nice to ponder what could happen if MSFT stopped being such a screwup, as John Dvorak does here, including this amusing "glass is half full" statement:

Because there is so much room for improvement at all levels, there's great upside potential for Microsoft.

the fact is that current leadership show few signs of even acknowledging their screwup status, far less attempting to address it. [btw, yes I understand the surface-level oxymoron of calling a $50B company a screwup. It's a statement relative to potential

Case in point, here's Forbes succinctly describing some of the challenges in an article entitled "Microsoft: Time To Plot A Comeback"?:

The Redmond, Wash.-based software giant faces growing competition in its core software business, which dominated the industry for two decades, and it hasn’t had a bottom line-galvanizing success in any other area recently. It was late to online advertising, letting Google (nasdaq: GOOG - news - people ) all but run away with that sector. It hasn’t had a big Web 2.0 hit yet. Thank god for Halo 3!

Ballmer's response? He's "not worried", according to Forbes. Indeed:

Just give Microsoft a little more time, Ballmer said.

Apparently the better part of a decade hasn't been enough. He goes on to add: 

"I’m happy with everything but everything needs some improvement –sort of like your kids," said Ballmer, who strode onto the conference stage toting a vente-sized Starbucks iced tea.

Steve must be the only MSFT shareholder who is "happy with everything". He must also be one of the few company followers who thinks MSFT is in good shape overall and just needs some tweaking around the edges. Frankly, I'm starting to wonder if the CEO's of MSFT competitors don't wake up every morning, check the web, and say "He's still CEO. Thank God!". I have visions of Schmidt, Jobs, Benioff, Szulik, virtually every Web 2.0 CEO, and even Ellison and Palmisano, uttering a collective sigh of relief each a.m., happy in the knowledge that with Ballmer at the helm the MSFT pit bull of old - which Joe Wilcox says "mauled IBM, Lotus, Netscape, Novell, WordPerfect and so many other high-tech companies in the 1990s" - will remain a fat and slow moving Saint Bernard, inspiring about as much fear and respect as a yapping Chihauhau.

Meanwhile, Goldman Sachs is beating the drum for MSFT (again), adding them back to their America's Conviction Buy List after taking them off six months earlier. Putting aside the fact that Goldman has been wrong about MSFT virtually every year since 2000, let's look at the specifics of what analyst Sara Friar said earlier when she reiterated her "Buy" and $37 target:

"Microsoft stands at a major juncture in its life cycle, with near term product cycles balanced out by longer term uncertainties as new areas as software-as-a-service, virtualization and open source [software] seek to diminish Microsoft's grip on the desktop."    

Hmm... is it just me or did Sara not get the Ballmer memo saying everything is in good shape? Seriously, this is one of the top-ranked software analysts, trying to make the bullish case for MSFT, and this is the best she can come up with? Does that sound like someone who believes MSFT just needs some tweaking? And I'm not talking about the list of "uncertainties" - we already knew those, and could make an equivalent list for AAPL, GOOG and every other company. It's her implicit lack of confidence.

And that, in a nutshell, really sums up the problem with MSFT. In the case of GOOG, AAPL, and virtually every other large peer/competitor, the market has strong confidence that those companies can adapt, overcome, and continue to grow and prosper. That's borne out by analyst's opinions, premium to market P/E's, stock performance, growth expectations, etc. In Microsoft's case, on the other hand, they're not nearly as convinced. Why? Is it just the "law of large numbers"? That's part of it. But primarily it's the post 2000 track record of poor "bets", even poorer execution, and chronic overspending, all of which come together in the lack of visibility wrt future earnings leverage. Hence the reason why even after five years of this stock going absolutely nowhere, $50B+ spent on buybacks, $30B+ down the hole in R&D, and $10B's of new "investments", most analysts still can't make a case for more than 20% upside from current levels, and the stock continues to badly underperform. Meanwhile, they have no trouble doing so for AAPL, GOOG and many others - despite their already spectacular runs - and those issues continue setting new all-time highs (AAPL and GOOG increasing more in the past month alone than MSFT has in the past 5 years).

All of which brings me to the opportunity cost of continuing to hold Microsoft. In my view, there's little doubt that GOOG will surpass MSFT in total marketcap sometime in the next two years (it's already above $200B). And while it's harder to see AAPL doing that even over a slightly longer timeframe, it's not impossible given current trajectories. But even putting these super-performers aside, MSFT is down ~11% YTD relative to the NASDAQ market generally. And this was meant to be the "big year". Do you think MSFT is going to increase 11% more than the market over the next twelve months to catch up for the past twelve? Possible, but unlikely. Outperform it by ~33% over the next year or two to catch up for the past three? Straining belief. 90% any time soon to make up for the past five? Fahgetaboutit!

The market, it seems, doesn't much care about what might happen if MSFT weren't a screwup. They only care that MSFT is one, and is in total denial about it. As critical as I have been, I have always been optimistic that this company could eventually get back on track. That optimism is fading. Turns out the market was right five years ago when they ignored Ballmer's rosy outlook and disconnected MSFT from the broader averages. Flash forward to today, and again the market is sending a negative message while Ballmer waxes poetic. Only now, the market is the sole one with any credibility.


Update: And the comedy of errors continues...

Somebody help me out. Is that Dynamics NAV, Longhorn Server, Viridian, Windows XP SP3, Office for the MAC, Silverlight 1.1, and CRM 4.0 (aka Titan), all delayed just this year alone? Or am I missing some other major ones (let's not even bother with the minor ones)?

Update #2 (10/24/07): Further to AAPL challenge and OSX vs Vista:

Nice. Sure, it's MAC fan Walt Mossberg. Still, it's difficult to argue that several of the features in Leopard aren't superior to Vista and/or better implemented. Also, that relative performance on similar hardware favors OSX. Meanwhile, MSFT pumps out some Vista performance updates (which in my experience provide only marginal improvement) and hosts holiday "preview events". And we wonder why AAPL is gaining market share at MSFT's expense...