Wednesday, February 06, 2008

Having Fun Yet?

I know I'm not. And if you think the market is getting it wrong, consider that MSFT was previously expected to make $2.09 per share in FY09. At a semi-reasonable 18X multiple, that would have generated a target price for the stock of around $37.62. Now, consider that some - notably Bernstein - think the YHOO deal could be .32 dilutive to that FY09 EPS target alone. In other words, it could drop to $1.77. If the multiple stayed the same, that would take the target down to $31.86. Which, not coincidentally, is virtually identical to what Canaccord provided today as they downgraded MSFT:

Canaccord Adams downgraded MSFT as they believe shares will come under pressure if the company raises its bid for YHOO. Note that the firm upgraded YHOO to Buy from Hold. Target to $32.00 from $40.00.

But wait, it gets worse. See, with all the extra risk and uncertainty, there's no particular reason to think the market will still award an 18X multiple. I'll leave you to do the math if it dropped to say 16X, or - God forbid - 12X. Additionally, no one knows exactly how dilutive this deal will be. That's because it's half cash, half stock. Now in theory, as MSFT shares continue to decline, so too does the value of the offer. There's just one problem: even if YHOO management decide to accept the deal (and their options are pretty limited), they're very likely to insist that MSFT get it back up to at least the original $31/share level (some are saying $36-$40 might even be required).

Since Ballmer appears to be intent on doing this deal (irrespective of the strong feedback shareholders whom he is meant to represent and work for are giving him), that would leave two choices: adjust the share multiplier higher (from its current .9509 of a MSFT share) - thereby resulting in even more shares being minted, further dilution for us, more downward pressure on future EPS, and a larger ongoing dividend obligation for the company - or change the 50:50 cash/stock balance to favor more cash which, since MSFT doesn't have it, would require taking on even more debt. And the more MSFT shareholders bail, the lower the stock goes, and the worse this non-virtuous failure loop becomes. Neat, huh?

Then there's the fact that while Dumb and Dumber say this deal will be breakeven or better within two full fiscal years after the deal closes, they also said that was excluding various charges. In other words, don't count on EPS after charges - or final EPS - to be breakeven, even through FY10. Related, there is no way that YHOO on paper is going to be worth this price. So at some future point, MSFT is going to have to take a huge charge to write down the "goodwill" difference between what they paid, versus what YHOO was actually worth. I guesstimate that that charge will be at least $1/share, and it could easily be $2 or more depending on what the final price is, how the integration goes, etc.. Needless to say, a $1-2 charge in some future fiscal will have the effect of wiping out a large part of MSFT's overall earnings for that entire year.

As I said in the last post, if you're a MSFT shareholder you should be hoping this deal gets kiboshed by either YHOO or regulators (however unlikely). Alternatively, you should hope that MSFT and YHOO come to some other accommodation. The best option there would be a standalone entity (either under the YHOO listing or a new one), into which both YHOO and MSFT contribute and MSFT shareholders get stock.



Our case-in-point arrived today when Canaccord Adams cut Microsoft from "buy" to "hold." Prior to today's activity, MSFT sported 14 "buy" or better ratings, compared to just 4 "holds." If this line of thinking begins to take hold on Wall Street, the shares could be looking at additional declines over the next few months. Additional fuel for the fire could come from the options pits, as the stock's Schaeffer's put/call open interest ratio (SOIR) of 0.44 ranks below 72% of all those taken during the past year. While we can sit and debate the desperation and necessity of Microsoft's bid for weeks, it is investor sentiment that will ultimately vindicate or scuttle the company's shares. And right now, investors appear to be leaning heavily toward the "scuttle" end of the spectrum.


  • The sad thing is that months ago when a Yahoo! bid was rumored inside the company, we all blindly believed SteveB when he came out and told everyone that it didn't make sense for a number of reasons. And now this...

    I'm with you...I am NOT having fun over this. As my own little group struggles with budget to go close deals with customers or a few dollars to market what could be a very lucrative business...our leaders are in the parking garage warming their hands on the cash their burning through...and tanking my stock at the same time.


    By Anonymous Anonymous, at 12:02 PM  

  • oy. we just break 30 bucks per share for a few shining moments and now this; clearly our leaders will do whatever they want to do regardless of us worker bees; I wonder if GOOG would just love to see this go through based on the picture you paint?
    great post, btw...

    By Anonymous Anonymous, at 3:47 PM  

  • My casual 'eyeballing' of MSFT over the last few months suggests to me a near/mid-term shift in sentiment. MSFT seems to participate in the selloffs but not the rallies. Considering MSFT is a component of the DJI, SPX and NDX (and countless funds & some additional ETFs) and given that weighting hasn't helped it in the rallies, 'twould seem MSFT positions are being unwound.

    (ps: apologies for the 'get a mac' joke)

    By Anonymous Charles, at 1:50 PM  

  • I am sooooooooo depressed. And for sooooo many reasons, including

    1. Lack of leadership and vision
    2. Lack of executive accountability
    3. Stock price: what other stock has done NOTHING for almost 10+ years!!??
    4. The spin... oh the incessant spin by our execs

    On a bright note, it may make leaving MS easier. I regret to say this as I truly love working here and love the company.

    I know I sound like a battered spouse, abused child, or kidnapped victim ... well it may be the best way to describe my relationship with MS....

    By Anonymous Sad, at 2:27 PM  

  • I'm SO with the poster "Sad".

    I've been with MSFT for 9 years. Long enough to remember the good old days. I joined thinking I could change the world, and for a few years in my sphere I did. And then the big company bullshit ground me and everyone around me to a halt.

    I am SOOOOOOO depressed in the same ways as the poster. And I could see it creeping in a few years ago, but I shrugged it off as "things will get better" or I truly thought that it was a fluke, that our leaders did want to see us innovate and get ahead.

    Now, I'm in the same boat. Interviewing outside the company frantically and feeling no qualms about leaving. All that management has done has shown immense disrespect (on so many levels) for me, my peers and shareholders. So I keep interviewing, dumping my shares and trying to de-tox myself from years of abuse.

    By Anonymous Anonymous, at 4:04 PM  

  • I am also incredibly depressed and saddened. Just as thing were looking up... Ballmer does it again.

    What I don't get is how can this be happening? How is it possible that one man with self-destructing tendancies get away with this? Why isn't the Board doing anything? Why are the shareholders allowing this? Why are his reports and execs going along with it? I recognize the Board may be incestuous and that he owns a significant share of MS, but still.... WTF!!!

    It pains me so much to be a part of MSFT these days. I so enjoyed working here. But these decisions, lack of accountability, lack of vision, self-destructive tendancies, ..... ugh I can't even finish this post.

    Extreme - reading your blog is like driving past a horrendous car crash. You don;t want to look because you know.... but you can;t help it..... and then you regret it and can;t get the image out of your head for days.

    I re-did my resume last week and am already talking to head hunters.

    Never thought it would go down like this.

    By Anonymous in shock, at 9:07 PM  

  • It just hit me - there seem to be so many parallels between Bush (the President) and Ballmer. Here are a couple:

    1. in denial
    2. fixated with their own albatrosses (Iraq; Google)
    3. history will not be kind to them
    4. running their country/company to the ground
    5. desparate
    6. surrounded by yes men
    7 getting away with it!!! yes, they are!

    I'm sure you can think of more...

    By Anonymous Anonymous, at 9:22 PM  

  • This is really unbelievable. I'm almost still in shock about it because I stood in a room with a bunch of people and heard Steve tell us every reason NOT to do this deal. And with our stock on the climb, I felt for the first time that we were headed back into the good days. As such, I held on to a sizable chunk of my options because I believed in the company.

    Now this.

    He single handedly destroyed my faith in his veracity and ability to lead in one fell swoop. My value in my options is gone for years now after waiting SO LONG for them to become valuable, I am sure the merger will be nothing but a goat rodeo of pain, and I no longer believe in the leadership of the company.


    By Anonymous letdown, at 7:55 AM  

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