Thursday, April 24, 2008

Q3 FY08 Earnings

I may or may not be covering this in detail today. To be honest, I'm close to packing it in wrt both MSFT and this blog. However, for those who wandered over here looking for the usual review, expectations are as follows:

The Street is looking for revenue of $14.5 billion and EPS of 44 cents. The company’s guidance was for revenue of $14.3 billion to $14.6 billion, with EPS of 43-45 cents.

With the YHOO thing still hanging over us, reaction to strong results are likely to be muted. And with GOOG and AAPL having already posted blowout results, anything from MSFT will seem average by comparison - which of course it is. On the other hand, negative results and/or weak guidance will be punished severely. Personally, I expect a strong report given higher than expected PC sales. However, I think guidance will be on the modest side given the declining macro economic picture and MSFT's typical conservatism. So tomorrow, the stock may be $1 or so higher best case, or $1-$2 lower worst case. Then we'll drift along some more until the YHOO thing finally gets resolved. If that's a merger, then the stock will take a hit and be dead money for two more years. And if it's walk away, then maybe the stock goes up $2-$3 until worries about how MSFT can curb GOOG's growth without YHOO take over and drive the price back down $2-$3. In other words, yawn.


On first blush it's not great and the stock is off 5% in the after hours session presently. At $14.45 billion, revenue is in the middle (exactly) of company guidance but light versus consensus. Considering how much further the US$ fell during the Q, that's particularly weak. EPS at .47 looks to be a solid beat, but there's some noise there wrt charges and I haven't detailed what was in/out yet. The item that jumps out is that expenses came in very hot. In particular "Cost of revenue" and "General and administrative". As a result, net income fell off a cliff. Again, I haven't detailed what's behind that yet, although a billion of it looks to be accounting for the EC fine. There's a note in the .ppt that says "Operating income" would have been $5.8 billion ex the fine, which would have exceeded company guidance of $5.6-$5.7 billion. Not that investors apparently care about the distinction.

Results by segment are as follows (technology guarantee impact making compares difficult):

Again looking quickly, Client sucked. And it seems to be not just the technology guarantee impact but also anemic OEM growth. The .ppt brags about the same 140M Vista licenses sold that we've been hearing about for a while now. So clearly there's been no acceleration wrt installed base upgrades either. Surprise! Not. MBD was also weak. I haven't delved further to figure out why. Server put in a strong showing as per usual. Kudos to that group at least. And E&D managed to eke out a paper profit (as long as you ignore intra-group transfers and the convenient "Corporate-level activity" bucket).

Guidance for Q4 is $15.5-$15.8 billion. The street was expecting $15.6 billion, so nothing too negative there. But EPS guidance is .45 -.48, whereas consensus was .48. So that's a guide down.

Of course, since next fiscal provides lots of time for things to change, to beg forgiveness, or for a YHOO merger to screw up compares enough to make burying a subsequent miss easy, and since having the stock drop too far currently isn't ideal given the pending YHOO merger, the company is able to look past Q4's set back and be unreservedly bullish for FY09:

  • Revenue is expected to be in the range of $66.9 billion to $68.0 billion.
  • Operating income is expected to be in the range of $26.7 billion to $27.4 billion.
  • Diluted earnings per share are expected to be in the range of $2.13 to $2.19.

Wall Street analysts were forecasting EPS of $2.00 to $2.20 per share ($2.10 consensus), on revenue of $66.5 billion.

Buybacks during the quarter were unsurprisingly light at around $1 billion.

Sample media reaction:



Tracy notes that revenues from the Client division - the Windows business - had been expected to be down 18%-20% year over year, but actually fell 24%. He notes that Microsoft believes PC market growth was 8%-10% in the quarter, below the company’s previous estimate of 9%-11%. I would note here that other estimates of Q1 PC unit growth are higher: IDC says units grew 12.3%; Gartner says growth was 14.6%.

Minimum 20% miss versus forecast on a business this large? Not good. Who is getting fired? Kidding, we know no one will be. And who to believe wrt actual PC shipments? FWIW, I'm going with IDC and guessing a mix shift back to lower priced/lower margin XP and towards Linux in UMPCs and emerging markets is what is really responsible for the miss - which is even more concerning.

Tracy notes that the Microsoft Business Division’s revenues came in about $20 million to $30 million below expectations. He says the server and online businesses were in line with expectations. He says the entertainment and devices segment was ahead of plan, driven by strong Xbox 360 sales

You know it's a weak report overall when MSFT is reduced to playing up E&D's results.


Thank God for the last minute "surge" today, or the maximum $2 downside target that I postulated yesterday would have been exceeded on a closing basis. As it was, the stock was down more than $2 during the session. But it managed to end the day down a mere $1.97. Hopefully you appreciate the psychologically important distinction there, because I'll bet dollars to donuts a bunch more of our cash got spent in order to ensure that result. So, let's call it $18 billion of shareholder wealth destruction. Not bad for one day's work.

Having listened again to the fifty something minute excuse-fest that passed for a conference call last night, I can see why investors were dumping. If I had a dollar for every "woulda, coulda, shoulda" that was uttered, I'd be rich today instead of just poorer like most shareholders. Liddell's attempt to blame the Client shortfall in part on some mysterious piracy problem with a Chinese distributor and their "market dynamics" (which when coupled with the recent MSFT/Novell/China announcement is probably really about Linux competition), while comically maintaining that there is no Vista problem (even though the "sold" counter is moving slower than Zimbabwe's national election results), just shows how much contempt this management team has for the truth and the intelligence of its shareholders. Most companies bend the truth. That's expected. But MSFT's current management team just dispense with it entirely.

I especially got a kick out of their self-congratulations for the wise "investments" made and diversification achieved, how good they feel about the way the business is performing, and how much they will have increased EPS by - assuming they make their targets - over the past three years or so (which conveniently have now morphed from the biggest product lineup in company history being well received by customers as recently as last Q, to "one of the most difficult economic environments we've seen". Huh?). Pop quiz: What has all this supposed goodness meant for the people they have a fiduciary obligation to - shareholders? Answer: Effectively squat. Had you simply invested in the indexes over the same period, you would have had a better return with much less volatility. Extending that to 5 years, you would have outperformed MSFT by approximately 34% to 50% ex-dividends (depending on whether you chose the S&P or the NASDAQ). And let's not even bother comparing returns to companies that have actually performed for shareholders like AAPL, GOOG, HPQ, or even IBM of all people.

I wonder if I'm unique among shareholders in that I'm only ever half-listening to their tired self-serving bullshit. Meanwhile, a virtual ticker tape of MSFT's moribund stock price this decade is scrolling along in my mind, serving to negate much of what they're saying and underscoring just how out of touch with reality they are. Based on market reaction today, it looks like at least some others reached similar conclusions.

Anyway, this piece includes analysts reactions following last night's results:

There's also some additional color on the financial sinkhole that is Online in this piece:

Again, Ballmer must have a really low opinion of the average investor's IQ if he thinks we can review data like this and still believe him that MSFT has a "solid" strategy here with or without YHOO. They don't. They have another financial clusterfuck that rivals Xbox, and investors are more than smart enough to see that - which partially explains the stock action.

Wednesday, April 02, 2008

Is the Sleeping Giant Finally Waking Up, or Just Rolling Over?

In the movie Tora! Tora! Tora!, when Japanese Vice-Admiral Isoroku Yamamoto is presented with the news that Pearl Harbor has successfully been attacked, he doesn't gloat. Instead, he shows great prescience and says:

I fear all we have done is to awaken a sleeping giant and fill him with a terrible resolve.

For several months now, I've been trying to determine whether the increasing successful attacks of competitors are finally waking MSFT up and relighting the fire, or whether the company is just putting more pillows over its head so that it can keep dreaming about the good ol' days of the late 90's - the corporate equivalent of a child's "can't hear you".

Support for the latter proposition is nearly endless, and I'll return to that in a bit. In fact, it's so abundant that my willingness to consider an alternate reality is itself ipso facto evidence of possible self-delusion. Holding the stock will do that to you. Nevertheless, there is some support for that view, albeit that it's much harder to come by. Case in point, this ZDNet article by Dana Gardner, who interestingly isn't much of a MSFT fan - which gives it all the more credibility:

Excerpt: (bolding mine):

The Google fear on the business model disruption, the Apple fear on the client disruption, and the Amazon fear on the cloud disruption, seems to be making Microsoft do what anti-trust regulators, Java, open source developers, Linux, Firefox, OpenDocument, IBM/Eclipse, Novell, and a chorus of Microsoft bashers like myself have been trying for many years. And that is ultimately to save Microsoft from itself.

Halllalulah on that last one. The piece contains several great links that are also worth a read, including this one by former softie Robert Scoble.

Unfortunately, there's the flip side that I mentioned earlier. Let's skip over the usual stuff like an Excel bug, a Word bug to keep that one company, a long-ignored Jet bug, and embarrassing IE performance scores (btw, can someone also tell me why IE - both 7 and 8 - choke on a large number of favorites when Opera, Firefox, and even Safari do not? Or why Safari can come to market with better standards support and a better mobile experience in less time than IE, and - at the risk of answering my own question - why MSFT hasn't ripped the browser out of the OS where it should never have been put in the first place?). I'm not even specifically focused on news of all the drivers that are still problematic for Vista SP1 along with failed install stories. After all, that was true of XP SP2 initially too, and God forbid that MSFT would improve over time - especially when this version of the OS is struggling so visibly.

No, the things that really concern me are reports of declining reputation and other branding issues:

Microsoft also came out on top when customers were asked to choose which company to rebrand. "It's gone from innovative and bold to stodgy and a follower," said one respondent. "But rebranding is only one step since it really needs a major shift in how it thinks."

Or how much additional share the MAC is picking up - here's a further nice quote to ponder on that score:

Huberty notes that a recent higher education survey shows Apple’s mind share tracks well ahead of the current market share - 40% of college students plan to buy a Mac, while just 15% actually have one so far.

Mary Jo Foley has a timely piece quoting Forrester and saying forget the noise, "Windows still totally and completely rules the enterprise roost". That may be true, but it's a very shortsighted view of things. IMO, if MSFT continues to sit back and let Apple lead technically (or at least from a user experience perspective - the phrase every convert I know uses to describe it is simply "I love it") and clobber the Windows brand from a marketing standpoint, then it's only a matter of time before consumer success for AAPL translates into business success as well.

Then you have the recent trend towards low cost portables, like the Asus Eee, with Linux as the default (and where Vista is a non-starter both price-wise and especially resource-wise). And the very concerning possibility that with the iPhone, Apple may have given birth to an entire new platform - taking a page right out of Microsoft's own Windows play book.

Another concern, though unsurprising, is Ballmer's absence from Barron's list of the world's best CEOs. Was it the failure to "deliver for shareholders", or the inability to be seen as an "excellent manager", that kiboshed his inclusion? Guilty on both charges would be my own input. Is the Board really so out of touch that it doesn't recognize the connection between confidence in the CEO and bullishness in the stock? Maybe they need a more concrete example - like the top holdings of the QQQQ as a percentage of net assets? Hmm...that is meant to be the tracking stock of a marketcap weighted index right? So, er, shouldn't MSFT be weighted higher than AAPL?

And finally we have the whopper, the YHOO bid, now rumored to be going to $34 - or maybe $36 - despite the already ridiculous premium of the current offer, ongoing executive and senior sales departures (the latter apparently coinciding with the annual bonus being paid out in March - go figure), comScore data showing continued search share erosion, the Alibaba folks wanting to trigger a contract clause that allows them to buyout YHOO's stake in the event of a takeover (particularly concerning since the Asian holdings are perhaps YHOO's strongest asset), childish anti-MSFT antics, and fantasy growth projections like this:

Take a look at the data below, and ask yourself whether pursuing the same "me too, just worse" strategy that has failed dismally so far, only in a super-sized and even more shareholder-hostile version via Microhoo, is likely to yield a different result?

Anyway, in trying to answer the subject question of this piece, I went back and reread an earlier post where I laid out what MSFT needed to do imo to turn itself around (lest you thought all I did was complain). It has been just over one year since I wrote that piece and two things struck me after reviewing it: 1) It stands up pretty well despite the passage of time (read: I would change very little, though I'm of course biased) and 2) There has been progress in some areas (implicit as well as explicit). That's a positive. But complicating the analysis - and one of the main problems - is that MSFT (the company) never appears to be on one singular path. Instead, you have to divine the direction of the whole by assembling various often conflicting crumbs of information from the constituent parts. As this article notes:

"Microsoft's left hand and right hand don't ever talk to each other -- but if they did? Whoa, watch out," he said.

How does the leadership of a company this disorganized and literally tripping over itself with respect to its go-to-market messages, branding, advertising, etc. (think Live, for example), convince itself that it can be the leader in helping others hone their image and advertising online? Maybe back in the 90's, companies would have sidled up for some insight from the master. Today, that master would be Apple, or less so GOOG, and the value of getting strategy/marketing advice from MSFT is pretty unclear - except possibly so you can do the exact opposite. For example, consider the following from this article:

"We are working with a broad cross section of our product groups," he said, adding that evangelizing Silverlight across the company is still a challenge, even though CEO Steve Ballmer has highlighted the technology as key to its future. "It's a big ship to start turning around."

Huh? Is the captain in charge and running the "ship", or is this the Exxon Valdez? Or how about a quote from this one:

That's all I'll say, but you can easily imagine how we can take those things -- music, some of the things we do with Zune; games, with what we do with Xbox and Xbox Live; things that we would do with the PC and the Web, with Windows Vista and Windows Live; what people do in business with Exchange, with Office -- and how we'll make those things really come to life on mobile devices, in the right way for a mobile device.

Imagining that requires no effort whatsoever. What's difficult to understand is why it hasn't been done already? Was someone actually content with being a distant #3 (or having say a whopping 1% marketshare in China) before Apple came along and kicked everyone's butt? Predictably, now that the latter has occurred, the company is finally mobilizing (sorry for the pun there) and spending vast sums to acquire Danger, license Flash from Adobe, and doing whatever else comes to mind - including playing for time by making forward looking announcements and even creating fictitious and misleading UI shots - to try and get back in the game. And the PR machine is pumping out "Mobile momentum" pieces almost daily, while Mr. Credibility himself, Robbie Bach, assures us that MSFT will gain more share. Recall what that normally means in Bachspeak - more $$$ going the wrong way.

Anyway, all of this is a rather long way of saying that after looking at the data for and against, I think the giant is awakening. That's something, and potentially constructive. However, my concern is that the breadth of that change is still too limited and the overall pace of change is grossly inadequate. Like Nero fiddling while Rome burned, Ballmer seems to be preoccupied with GOOG while MSFT melts down - or at least while the first embers, which had already been apparent for years, now threaten to turn into something much more serious. Hence the recent ill-advised and fiscally irresponsible YHOO bid.

Barring a leadership change (which sadly isn't in the cards), MSFT's best bet is seemingly that emerging market growth bails the company out long enough to get its act together (a tall order given the competition there from Linux, along with heavily discounted MS pricing). Because at this rate, it's going to take current management at least several more years that they don't have to get there - assuming they ever do. Meanwhile, AAPL, GOOG, and others (Firefox, etc.) are going to continue to grab significant additional share in their respective markets - much of it at MSFT's expense - based on current momentum alone (not to mention their generally better strategy, agility, efficiency and execution). Against that backdrop, don't expect the stock to cease its now five-year plus flatline.


Update: Related developments...

Michael Gartenberg, vice president and research director at Jupiter Research, suggested that rather than acquire or partner another company to gain ground on Google, Microsoft should turn inward and focus on execution of its own online strategy. The company has developed innovative online services behind the scenes but has been slow getting those out to users, he said.

FWIW, while I agree with Gartenberg that MSFT has some innovative online services that need to get out the door faster, focusing internally on the current strategy isn't the answer. That's what the company has been doing for the past several years and it has been an abject failure. MSFT needs to quit the "me too, just worse" strategy. Instead, it needs to go back to basics. Forget the envious dreams about GOOG's $ signs. What customer isn't currently being well served? What are their needs that aren't being met? What unique core competencies does MSFT have that it can bring to the table? What partners exist who, for their own reasons, would want to align with MSFT and could be leveraged? Execute on that, and while MSFT many not ever dislodge GOOG, it could at least start to grow share - which is more than it has been able to do so far, despite years spent and billions lost.