MSFTextrememakeover

Eight Years of Wrongness

2008-06-11T10:07:00.001-07:00

Warren Buffett is quoted saying that his favorite holding period for a stock is "forever". I'm not ready to go quite that far - and in practice neither does he - but I do subscribe to a long term investing philosophy generally. For example, I bought my first MSFT shares back in the early 90's. Like most holders that decade, I did very well. Then came this one, which has been an absolute disaster.

It's sobering to realize that during Ballmer's term as CEO, MSFT has underperformed almost all of its top tech peers (including AAPL, IBM, HPQ, SAP, INTC, CSCO, SYMC, NOK, ORCL, ADBE, RIMM, QCOM, Ebay, and AMZN), and badly lagged the major averages. We may even see our third plunge to test the 2000 lows during his watch. Unbelievable. There may be another major technology CEO with an equivalent or worse track record who is still in power, but a name doesn't come readily to mind. Indeed, it’s instructive to note the four companies who didn’t make my list above: DELL, YHOO, Sony and Sun. In other words, four well-publicized flameouts/turnaround stories (depending on your perspective), all of which have new CEOs. Go figure.

That performance record would be embarrassing enough on its own, but it comes in spite of going through an unprecedented amount of our cash on buybacks (nearly $43 billion worth in just the past three fiscal years) and other schemes that were supposed to drive the stock. It's also despite spending more on R&D than virtually anyone in the industry, and more than GOOG and AAPL combined (nearly $20 billion in the past three fiscal years alone). Meanwhile MSFT's senior leadership have collectively been paid billions over this period, while leading the industry in insider selling every year (net of purchases, almost 350 million shares sold over just the past 5 years). You are expected to be patient and wait for returns over the "long term" (still undefined, but has already exceeded 10 years - think Jim Carrey in Ace Ventura and “If I am not back in 5 minutes….just wait longer”.), but they want their return up front.

Against that backdrop, it should come as no surprise that a shareholder was recently driven to write about "Microsoft - A Decade of Gross Corporate Negligence and Destroyed Shareholder Value." It’s a good read, and kudos to Bishop for publishing it – that probably didn’t earn him any brownie points with management.

FakeSteveJobs (aka Dan Lyons of Forbes) also said something worth reading here:

There's something really scary in the voices here. It's in the tone. You know what I'm hearing? It's disgust. Nobody comes out and says it, but these guys are fed up with Microsoft. They're not even angry. They're just fed up. They've had it. They stuck by the company during the DOJ trial and the antitrust mess, because hey, what investor doesn't love a monopoly. The guys on Wall Street don't care if you lie, or cheat, or bully your rivals -- as long as you're winning, and making money, and as long as the stock keeps going up.

What they won't stand for is fuck-ups. Incompetence. Mistakes. And the Borg has been nothing but fuck-ups for what -- three years? Listening to these investor dudes talk I'm reminded of a time in the late 1980s when Wall Street guys began ranting about Digital Equipment Corp. For years DEC had been their darling. Ken Olsen walked on water. But suddenly Ken Olsen was a doofus, an idiot. The company which once had been so powerful and so admired almost overnight came to be seen as a loser that couldn't adapt and change.

His site is offered as humor, obviously, but he often weaves in good insight. That’s an example, imo. Certainly, there has been another major negative sentiment shift since the YHOO offer and the latest quarterly results. I've been a shareholder for a long time and I have never seen the stock as weak as it has been these past months. Down some ~14% more than the market on the year, fifth worst DOW 30 performer YTD, and trading at [just] 14.8x forward earnings. Looking at the chart, the uptrend line from February has been obliterated, and major support has been broken as well. We’re seeing a little relative strength these past few days, but even that looks tenuous.

Some readers may be surprised that I was initially a Ballmer supporter. Not for CEO necessarily (I felt that he and Gates should have resigned after losing the DOJ case), but generally. I admired his tenacity and positive outlook. I still do. I'm even happy to give him credit operationally where it's deserved. For example, a good job has been done against traditional competitors in legacy markets (with the exception of Apple). On balance, after a rocky start and some noteworthy exceptions (e.g. Firefox), he has done a decent job of responding to the newer threat posed by free and open source software. Broadening MSFT's worldwide presence with foreign R&D centers is another positive on his watch, though the company is still too Redmond-centric. The addition of ERP/CRM made sense, though it’s been botched badly imo. Maybe in the fullness of MSFT-time (i.e. decades) it will live up to its potential. Gaming, well…I guess you could credibly say that it has been the only source of “cool”. It has also contributed to revenue growth, which overall has been solid under Ballmer (though the company wasn’t exactly on life-support when he took over). On the personal side, I respect him for not bailing on his shares to the degree that say Bill has (the latter will be out of the stock completely within 10 years based on his current pace of selling). And I admire his work ethic. He may well be the world's hardest-working billionaire. Also, the most passionate. My concern is whether or not the company has been effective under his leadership. Rightly or wrongly, the buck stops with the CEO. And when I look at the totality of MSFT’s performance under his reign, it's not a pretty picture. In fact, it's an epic fail.

There are too many issues to mention, but let’s review some of the real lowlights:

Losing the DOJ and EU cases, which has resulted in $10B’s in fines and (more importantly) permanently damaged MSFT's reputation.
Failing to aggressively leverage MSFT's cash horde buying promising companies at the bottom of the dotbomb for pennies on the dollar (btw, not 20:20 hindsight on my part – I posted that MSFT should do this in real-time back then).
The Longhorn clusterf!*k. The long-term damage of which continues to this day, will never be fully quantifiable, really began the process of confidence erosion in both the management team and company more generally, and may prove to be a decisive turning point from which the company never recovers.
Allowing Xbox to dig a $6B hole in the ground.
The "emerging bets" which collectively have been a bust.
Allowing IE to stagnate after risking the company and paying $B’s in fines primarily to beat Netscape and become the browser leader.
The major opportunities that were missed while leadership was otherwise preoccupied/distracted (Search, Advertising, Web 2.0/SaaS, etc.).
Losing digital media to AAPL.
The financially-retarded one-time dividend and the ongoing stock buyback games.
The sorry performance of the stock (which has resulted in part from all of the above).

Current management tell us that the company is “stronger and better positioned today” than it was in 2000. They may even believe that, but the market clearly doesn't. And available facts support an alternate conclusion. Some examples:

1) "Vista is a success".

Reality:

Management can claim it “sold” 150M licenses and call that “success”. But in virtually every other way – versus expectations, given a ridiculous 5 year gestation period and reported $5-$6B price tag, media reaction, corporate adoption, FPP retail sales, the company’s own expectations, and most important the competitive need – it’s a disappointment. Leadership are also blasé about the future implications that this underwhelming release may represent. I’m not. How many who have downgraded to XP - a significant number by all reports – will be harder to sell to next time? How many have switched or will consider switching to a competitor as a result? How many OEMs are pissed off and will now embrace other options like Acer is doing with Linux, or make comments like this from Intel’s Ottelini? And what about current impact? Windows marketshare, while still above 90%, has fallen to its lowest level ever. And others, particularly AAPL, have been steadily gaining share. More importantly, MSFT has arguably ceded undisputed technical leadership in desktop OSes - the core of what the company does - to Apple. It pretty hard to underscore how much of a strategic blunder that is.

The hope here is that Windows 7 will be the must-have product that Vista wasn’t, and the company is busy touting that promise regardless. While I’m optimistic that Sinofsky will prove more effective than his predecessor, and actually support the cone-of-silence approach he’s getting crucified for in the media currently, he doesn’t have carte blanche to make major changes - or five years to do it in - like Allchin did. I’ve long argued that MSFT needs to dump some backwards compatibility and come to market with a leaner OS to have any chance of keeping up with OS X and Linux. It should have been done with Vista, at least for a consumer version which could act as a showcase for innovation (assuming any was forthcoming). But that’s not in the cards on this iteration. So Sinofsky is going to have to focus on a few new killer features, addressing some of the major issues that still plague the Vista code base on which it will be riding, and perhaps work on the fit and finish that was so sloppy in Vista (inexcusable given the development timeframe). Bottom line? “Success” for Windows 7 will be stopping share erosion at whatever level it has dropped to by then.

See two additional pieces here:

Microsoft: Bernstein Trims Outlook For Vista Adoption

“The inescapable conclusion” of the survey, he writes, is that “support for Vista has been battered across all enterprise sizes and corporate constituencies.” He finds that “the Vista cycle looks likely to be materially less robust than indicated in our prior survey.”

Desktop Windows: Is it time to "cut and run?"

Until now, I've been advising Vista fence-sitters to wait for Windows 7. However, last week's "big reveal," in which Microsoft finally confessed that Windows 7 will be nothing more than "Vista warmed over," has forced me to reconsider my position. I'm now more convinced than ever that Windows is doomed - at least on the enterprise desktop.

2) "We have a solid strategy in Online".

Reality:

MSFT's Online efforts have been a disaster. Indeed, the company's performance has been the worst of the four major players - and they all managed to turn a profit versus lose billions.

It has become clear the plan hasn't worked -- which is the main reason Microsoft tried to buy its way into competitiveness by acquiring Yahoo, a deal that died May 3, when Microsoft withdrew its bid for the Internet company.

WSJ May 17, 2008

More bad news here:

Google Search To Surpass Size of Microsoft Windows in 2009

3) "We are winning this generation of gaming".

Reality:

Xbox, while more successful than Online on a comparative basis, has been a financial sinkhole of epic proportions. More than twenty billion dollars “invested” over nearly a decade, not to mention countless amounts of management’s time and “talent”, for what? If it wasn’t for creative accounting this fiscal, Xbox would still be unprofitable some 6-7 years and $6B-$7B in losses later. Speaking of the warranty charge that was retroactively buried into a previous fiscal, here’s a report on what was really to blame. Short form: to save perhaps $10M’s, MSFT designed the graphics chip in-house rather than using an outside expert – eventually resulting in the $1B+ warranty/recall charge. Smart. And remember that hasty and breathless PR release a few weeks ago about being “first to reach 10M units in the US” and this metric historically determining the winner? Well, that was because Nintendo was set to reach that figure and surpass MSFT a few weeks later. Bottom line, in all likelihood MSFT will finish this console round dead last of three:

4) "We can reach 40% share in smartphones".

Reality:

Microsoft has been pursuing mobile in some form or other for nearly a decade. The result? A distant 3rd to 5th place depending on whose figures you use. And while there has been better success in the smartphone sub-segment, Apple has surpassed MSFT there in less than one year, at least for North America (MSFT still holds a lead worldwide, though I will be surprised if that holds up through 2010).

And with the $500M Danger acquisition, we can assume that Mobile would join the stable of unprofitable MSFT “investments” if costs actually got apportioned properly. Unfortunately they don’t (gotta love those inter-group transfers and that convenient “Corporate Activity” slop bucket for everything else), and MSFT doesn’t break out the detail for Mobile anymore regardless (or ERP/ CRM).

More here:

Considering this set of competitors, I don't think Microsoft has a snowball's chance in hell of reaching 40% of the global market for smartphones. Not in four years, not ever.

5) “We have the best browser”

Reality:

I’m not sure what leadership means by best. Fastest? Not on most benchmarks I’ve seen. Most standard? No, although the team is at least trying to catch up. Smallest/fastest install? Um, no. Best mobile experience? Not according to most reviewers. While I’m on it, how did AAPL get to market with a better mobile browser than Microsoft, the browser leader? Additionally, why hasn’t Microsoft bought and incorporated IE7 Pro – the must have add-on for IE? Right now, the average IE user has to do without this functionality or, if they hear about IE7 Pro and go to download it, they get prompted to select GOOG as their search engine. Brilliant.

Meanwhile, Firefox closes in on 20% share.

6) “Zune is succeeding”

Reality:

Okay, you get the picture. I won’t go into detail on all of the rest like IPTV (10 years, $10B invested, still no material return), etc.

What do you think current perception of MSFT would be like if:

Vista had been the must-have upgrade it should have been?
The company had embraced the internet and led the move to SaaS versus resisting both?
Online had managed to at least turn a profit, if not hold share?
Xbox was leading this round of gaming and was actually profitable versus just creatively so?
Windows Mobile had generated even half the excitement that the iPhone has?

Do you think that maybe the annual P/E chart wouldn’t show this clear downtrend, which keeps negating the positive impact on share price that otherwise might be expected from what little earnings gains have occurred?:

Meanwhile, look at some other critically important metrics:

Efficiency:

Back in 2000, MSFT was one of the industry leaders in both revenue and profit per employee. Now look. While it’s still above average in income, revenue per employee is actually below the S&P average. Compare that to AAPL, who matches the S&P figure for revenue/employee – and they don’t have the leverage of the OEM model that MSFT does.

Brand:

When you trail IBM, you know you have a problem.

Marketing:

As I’ve noted before, Microsoft’s marketing is an embarrassment. Their PR is too, but that’s another matter. Perhaps the most glaring example of this is the failure to respond to Apple’s PC/Mac TV ads, something that Gates denied is having a negative impact as recently as the D conference a few weeks ago. Huh? Earth to Bill, come in. This is the same company that wants to be a leader in advertising, right? And the one spending $300 million to makeover its image?

"Nobody messes with anyone in the tech industry the way Apple has messed with Microsoft," says Enderle. "It's the first time I've ever seen a major national campaign that disparages a competitor, and the competitor just sits back and takes it. If somebody tried to do that to Oracle, you wouldn't be able to find the body."

Help may be on the way, but why did it take so long? Why has the company allowed AAPL to effectively define MSFT’s own brand in a negative fashion? Why was it Lenovo, not MSFT, who came up with a smart counter ad? How come MSFT’s Vista marketing team hasn’t been able to come up with something compelling like this (albeit a little rough), even though Robert McLaws was able to do so by simply offering readers of his blog a chance to win a PC?

Conclusion:

Like many, I have been holding out hope that MSFT would gets its act together. In the first two fiscal quarters that looked like it might be happening. But then the wheels came off the wagon and it’s been down hill ever since. I’m not just talking about the ill-advised and poorly handled YHOO bid. I think a lot of folks, myself included, reassessed after Q3 and wondered how others (AAPL, GOOG, less so HPQ, etc.) have been able to sustain successive growth and earnings surprises for years in some cases on the back of modest R&D expenditures and new product/service offerings, and yet the largest R&D spend and product line up in MSFT's history wasn't able to deliver even three consecutive quarters of the same.

As a stock, MSFT is done - stick a fork in it. And not just past and present, which has seen the terrible performance mentioned and is the reason, for example, that the QQQQ underweights MSFT in favor of overweighting AAPL and others (despite its mandate to track the index). I mean moving forward. If you want dividends, there are far better plays. And if want equity appreciation instead, make a list of MSFT’s top competitors, throw a dart at it, and invest in whoever you hit. More rationally, buy the index or one of the technology-specific ETFs. Either way, you’ll likely do much better over the next 5 years and have less volatility.

As a company, MSFT will obviously continue on for some time. But I will be surprised if 3-5 years from now (maximum), growth in the cash cows hasn’t come to a screeching halt and the company hasn’t been forced to layoff at least 10% of its employees.

All of this assumes Ballmer is still at the helm of course, which sadly is a good bet:

Microsoft CEO Steve Ballmer To Step Down Within 10 Years

Don’t misunderstand, he isn’t the source of all that’s wrong. But he is the enabler that allows it to continue (with the acquiescence of our do nothing Board of Directors).

So under a Ballmer-led administration, expect more of the same. Specifically, a general lack of accountability and urgency within the senior management ranks, a myopic strategic focus on protecting the cash cows while paradoxically paying inadequate attention to the actual products themselves, a related failure to spot new trends and get out in front of them (invariably resulting in a desperate, expensive, and often unsuccessful attempt to play catch up later), a staggering annual R&D spend that produces lots of research papers but a shockingly small number of promising technologies and even fewer successful new products, variable execution that runs from great to poor but is on average weak, a marketing effort that is simply atrocious, a bunch of very expensive "investments" that have best-case paybacks measured in decades and appear to be almost totally focused on driving revenue not income, and of course the ever-present maniacal focus on the latest competitor du jour, whose market the company currently covets or feels threatened by.

Meanwhile, OSS, AAPL, and others, will continue chipping away at the legacy cash cows, gaining share and driving down margins even where share is retained. So in addition to continued PE compression, there’s a good chance that “E” itself may start to decline as well.

So it's time for me to listen to the fat lady who has been singing for years now, and finally pull the plug. I can't keep waiting another 11 years for MSFT's leadership to deliver the returns that say AAPL's have in just the past 12 months, despite struggling (and that's on top of 2000+% this decade). I'm also increasingly concerned that under this leadership team the long-term flatline will eventually be resolved to the downside versus the up, with all the implications for additional shareholder value destruction that implies. As one pundit summarized it:

In short, I think the market sees Microsoft losing its grip on computer users and having nothing to take its place when those users start leaving. Jack's right that they haven't started leaving in droves yet, but the market is a forward looking mechanism and senses that at Microsoft there's a greater chance of ramping down than ramping up.

So with that, I announce the end of my MSFTextrememakeover blogging career. The timing seems right as this is my 100th post. Good luck to all those who continue to hold MSFT. I also wish the very best to MSFT's employees, especially folks like Mini-Microsoft, Dare Obasanjo, and others who have pushed for change from the bottom up at some considerable risk to their careers. Ditto folks on product teams like Live Writer, etc. who somehow managed to get something great out the door despite the obvious organizational dysfunction. Finally, thanks to media folks like Todd Bishop, David Hunter, and others who cited me from time to time and got others to read my input for whatever it was worth - which apparently wasn't much.

Anyway, best wishes to all. Extreme out.

Update:

Ten Reasons Why Steve Ballmer Should Be Fired (step down is sufficient)
Some thoughts on a Microsoft after Gates (and not just because he mentions me)
UX Taskforce: they’re listening (Here’s a thought: Why doesn’t someone senior in the Windows group publicly acknowledge that they’ve taken this feedback and are working on it? Ed Bott thinks it’s pretty amazing, and he seems to know a thing or two about Vista. Oh, and sending a message that “we’re listening to our customers”, especially when they’re offering to help you ~~fix your mistakes~~ improve your product and for free, couldn’t hurt right? Fake it if you have to, you could use the positive PR)
Microsoft Declares Quarterly Dividend (our thimbles runneth over)

Update #2:

Who Played It Worse: Microsoft or Yahoo?

Excerpt:

Yahoo destroyed itself to save itself. Microsoft tried to get stronger, but only ended up exposing its own weakness. Somehow Google emerged triumphant, effectively neutralizing its two biggest competitors.

Microsoft's Anti-Google Survival Guide

Excerpt:

Buying international properties outright may be tricky, but buying up minority stakes in overseas leaders such as Baidu.com (Nasdaq: BIDU) in China, or Russia's Yandex, will give you a toehold in faster-growing markets abroad.

Ya think?:

Microsoft: Four Ways To Improve The Business

Excerpt:

Here’s his four-part plan for energizing the company:

Innovate! “Multi-year investor concerns about the company’s ability to innovate have only increased in recent times,” he writes. “Outside of the “Surface” product, we have seen little from the company that could be labeled as being truly innovative. Innovation is key in boosting opportunities for Microsoft and in its battle against threats from Open Source software, SaaS, Online Advertising, Apple, Google, etc.”

Stop taking the iterative approach to product development. He asserts that “the ‘Hey, that was only Version 1′ approach to building software and products is ancient and creates a flood of unwanted negative publicity – Zune 1.0, Vista/SP1 are just some examples.” Parakh says that a key here is “a flawless user experience the first time any product is launched.”

They need a new branding strategy. “The use of Microsoft and Windows for corporate products is fine,” he writes. “However, anecdotal conversations with multiple individuals reveals that the use of Microsoft or Windows while branding consumer focused products increases the likelihood of a negative perception of the product (even if unwarranted), thanks to the immense negative publicity (news media, Mac/PC ads) received over the last several months and years.”

20% time? “Microsoft also needs to be nimbler in responding to the competitive environment and provide increased latitude for employees seeking to innovate.”

Q3 FY08 Earnings

2008-04-24T09:51:00.001-07:00

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.

Results:

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:

And:

Microsoft: FY Q3 Windows Demand Falls Short Of Forecast

Excerpts:

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.

Update:

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:

Microsoft Shares Stumble; Earnings A Mix Bag; Xbox Strong, But Windows Disappoints; Waiting For Yahoo

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

Microsoft Cuts Outlook for MSN, Online Display Ads Weakening

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.

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

2008-04-02T11:38:00.001-07:00

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:

It’s good news, bad news: Microsoft gets its Internet act together

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...

Real threat or tactic? Yahoo’s stock plummets on threat of Microsoft pulling bid. (I'll guess "tactic", unfortunately, but at least it suggests MSFT may finally be prepared to play hardball)
Microsoft's Savvy Open Source Move (this is smart)
Killing XP: Microsoft's Fatal Error (this one not so much)
Who uses MS Live Search? (scary if correct)
Microsoft Announces Extended Availability of Windows XP Home for ULCPCs (surprise! not)
With Yahoo deal off, what next for Microsoft? (talk about premature, but still a good read). Excerpt:

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.

Breaking News: CVP Will Poole Certifies Another Laptop as Vista "Capable"

2008-02-29T11:28:00.001-08:00

Granted, you may not get the "full" experience - though some might argue that the difference will be marginal. However, it will mean another chip sale for INTC. And isn't that all that matters?

Seriously, what an embarrassment. See the story that Todd Bishop broke here:

Full text: Microsoft execs on Vista problems

Additional coverage everywhere else including:

I suppose there's some way to spin this in a positive direction - and no doubt MSFT leadership will try. Here's their first lame attempt:

Throughout this process, Microsoft employees raised concerns and addressed issues with the intent to make this program better for our business partners and valuable for consumers. That's the sort of exchange we want to encourage. And in the end, we believe we succeeded in achieving both objectives.

Unfortunately, the record appears to show that while employees raised the concerns (to their credit), they were overruled by senior leadership. In other words, there was a willful decision to screw over customers and even OEM partners in order to placate INTC. Great judgement call if that's the case.

At least the Sinofsky summation shows there's hope for Windows - and the company more generally - under his leadership.

I'm not a lawyer, but these revelations would appear to be more than sufficient for the plaintiffs to win their pending class action lawsuit. So expect another $500M+ eventual judgement. Which makes the following all the more prescient:

In a February 2006 e-mail, Robin Leonard, a Microsoft employee, wrote that Wal-Mart officials were "extremely disappointed in the fact that the standards were lowered and feel like customer confusion will ensue."

She added later, "Please give this some consideration; it would be a lot less costly to do the right thing for the customer than to spend dollars on the back end trying to fix the problem."

"Do the right thing for the customer". Now there's a concept. So will anyone senior get fired for having seemingly done the wrong thing for customers, thereby damaging perceptions of Microsoft and its most important product in the process? Of course not.

Not coincidentally, MSFT is dropping Vista prices for retail skus; A move that is long overdue since the pricing there is ridiculous and sales have been abysmal.

All in all, a nice cap to a rotten week of news and stock action for MSFT.

Awooga, Awooga... Abandon Ship!

2008-02-23T13:34:00.001-08:00

What do you do when you find yourself aboard the USS Caine and unable to locate enough fellow deckhands willing to stage a mutiny? Why, abandon ship of course. And that's what MSFT shareholders have been doing - in droves. I wonder if Ballmer is holed up somewhere right now, in front of the Board of Directors, with a scene like this playing out? Okay, maybe not. Must be my excitement over the upcoming Academy Awards talking. Reality is probably more like Alfred E. Neuman's "What, Me Worry?" anyway.

Meanwhile, MSFT shareholders are paying the price - a $73,000,000,000 tab in just the past three months ($85B if you go back to the peak in Oct.). Of course, some of that was the mysterious inability of the stock to hold its rally coming out of the strong earnings report - something that had already gotten my spidey senses tingling and waiting for the inevitable "bad news" shoe to drop. No way anyone knew something was up in advance, right? Like say, YHOO's and MSFT's M&A advisors from Wall Street? But if you want to explain that away as just market related, compare and contrast how HPQ fared in an equally bad environment following their strong report (I'll come back to them later). Then you have the market meltdown itself, which is responsible for a good chunk of the loss. And finally you have the massive fallout from the YHOO deal. A few billion here, another few billion there, $40B+ on top of that, and pretty soon you're talking serious money.

Consider the implications, for a moment, that if I left you with just two clues: "MSFT" and "$27.68" (it actually hit $27.20 intraday), I could be talking about 2000, 2001, 2002, 2003, 2004, 2005, 2006, 2007, or now 2008. That's right, the stock has hit that level at some point during each of those years. How can anyone still be a CEO with a track record like that? Ballmer is like a small child who, having been told not to put their hand on a hot element, continues to do so anyway. Only in this case, it's our hand that repeatedly gets burned. Or - at the risk of belaboring the point and overextending the child analogy - maybe he's like the teenager who wants money for a home recording studio because he decided on a whim that he's the next Ray, or for a boxing ring in the back yard because he's convinced he's the next Rocky, or for a big-ticket plane to park in the driveway because he watched Top Gun and figures he could be the next Maverick. All of which end up going to waste, due to the subsequent half-assed dedication and limited attention span.

Funnily, this post was originally going to be about how maybe, just maybe, Microsoft was finally getting past the denial stage it has been in for most of this decade, and starting to acknowledge - and even get serious about attempting to fix - its many obvious problems. Now admittedly, you had to make like Andy Dufresne in The Shawshank Redemption and swim through a river of [MSFT executive and pr] crap to get there - truth still being anathema to current management. But there had been a series of moves recently that struck me as atypical: the YHOO bid - no matter how ill-advised (confirming that MSFT's Online efforts have failed miserably), the Danger acquisition - no matter how costly (acknowledging that Windows Mobile is being clobbered by the iPhone in the consumer space and is now at risk to even stay an also-ran in the business market, despite nearly a decade of investment), Ballmer admitting to having had "fits and starts" in the Xbox business (translation: it has been one ginourmous clusterf$k, which looks to be getting worse not better), several executive departures in areas that are all clearly struggling - dare I say some long overdue executive accountability? (I would even have entertained right-sizing the exec ranks, if it wasn't for the fact that they promptly turned around and minted even more VPs via promotions. Gotta keep that agility-sucking "top ~~500~~", er... "top ~~800~~", er... "top 1000", 1200?, in tact), and finally - gasp! - Ballmer acknowledging that AAPL is kicking MSFT's butt and that they need to do "more to market Windows" (wow, and that only took a few years of AAPL bombarding the public with Windows-bashing ads and increasing their marketshare at MSFT's expense).

FWIW, I attributed all of this to either fear (i.e. MSFT has seen the future and doesn't like the view) or MSFT management finally getting sick of being a punch line for most of this decade - the edge going to the former (not that it much matters if the end result was achieved). But somewhere along the way I started to doubt my entire premise. Maybe I just saw what I wanted to? Which is why you're getting this post instead. After all, what right-thinking management team with problems like those below, would turn around and make a huge offer to buy someone even more screwed up?:

Windows

Home Server

Windows Home Server Still Crippled By Corruption Issues

Live

Why Ray Ozzie can't save Microsoft

Office/CRM

Xbox

Sony's PS3 overtakes Xbox 360 in US sales
Microsoft Offers 'Mea Culpa' For XBox Market Share Loss(copping to incompetence in forecasting, apparently being preferable to admitting lack of competitiveness)
PS3 Outsold Xbox 360 In First 14 Months
EA predicts 2008 hardware sales, expects PS3 to be on top
Gaming Consoles: Wii To Dominate Sales This Year, PS3 Next Year
Xbox failure rate is around 16 per cent and rising
Lessons from the Death of HD-DVD

Zune

Apple iPod Sales To Take Off Again? (AAPL)

Online

Search Trends: Google Advances in Latest Search Data

Mobile

Marketing

Microsoft rebrands healthcare software as Amalga (Amazing that they didn't go with "Phlegm" instead)

Legal

And that - believe it or not - is just a quick sampling. Wouldn't it be an idea to maybe get your own clearly dysfunctional and threatened house in order first, before embarking on trying to clean up someone else's? Is there any doubt that management's credibility would be higher, and the market would be responding more favorably to the proposed deal currently, if that had been true?

Ballmer, imo, has one opportunity to get things back on track. Given the hostility of the YHOO Board to the offer, the list of good people jumping ship or being pushed, the severance programs being put in place that would add billions more to the cost of this already insanely valued deal, its declining share in search, recession risk in this space broadly, and the clear message being sent by MSFT shareholders, Ballmer should revoke the proposal. Just sail away. Chalk it up as a somewhat successful ramming of an enemy cruiser (even if you had to disable, at least temporarily, a few of your aircraft carriers to do it), and leave them to sink via additional shareholders lawsuits and customer/employee defections. Maybe buy just the parts you really wanted at some future date - for ten cents on the dollar versus a 60% premium - when they're on the block and being sold as scrap. And yes, give up your dreams of blowing up the GOOG battleship anytime soon. Like the Bismark, you let that one get built and sail out of port right under your nose. But instead of chasing it recklessly now, maybe see if you can manage to successfully maneuver your own little destroyer-minesweeper for a change, without taking on water continuously and using shareholder cash to fuel the bilge pumps. Perhaps - and I'm just spit-balling here, like Jack Nicholson in A Few Good Men - use some of those $10B's in R&D every year to actually innovate and say, eventually make battleships obsolete? Oh, and do a mea culpa to all shareholders and set about making the current MSFT the best fighting vessel it can be. 'Cause it sure ain't there currently.

Meanwhile, accepting the Oscar for best CEO is... envelope please - HPQ's Mark Hurd:

Hewlett-Packard CEO: We can do even better

Excerpts:

It's just that the CEO who may be the best big-company operator in the country is all about making uncomfortable observations that so far have ended up being the right call for his company: Market share isn't the best goal to shoot for; even good businesses need to be examined carefully (especially their cost structures); and strategy and execution trump vision any day of the week.

(Take special note of the "cost structures" and "strategy and execution" parts)

And,

Hurd doesn't talk about the competition.

How refreshing.

He boils down the CEO's responsibilities to three tasks: setting strategy (not offering a vision); aligning operations and modeling ways to execute on the strategy; get the best team to help the CEO. "There are a thousand distractions that keep you from doing that," he says. But that's where the focus needs to be.

Pretty clearly, Ballmer has too many "distractions" as it is. The last thing he needs is another super-sized one. That said, will he be smart enough to recognize that and disengage? Sadly, I doubt it. Egos are now involved. So the silver lining is that this decision is big enough and reckless enough that if/when it goes forward, he'll either rule the ocean if it succeeds or be scuttled when it fails. And since we've seen this movie before, odds heavily favor the latter. Let's hope there's enough of the ship left by then to resurrect. Maybe Captain Hurd will be looking for a new berth by then...

Reprieve, Or Just Haggling On Final Price?

2008-02-10T16:28:00.001-08:00

Word over the weekend (from various sources) is that YHOO's Board is set to reject MSFT's bid on Monday:

Yahoo Board to Reject Microsoft Bid

If true, you have to wonder what YHOO leadership's real intention is here. Could they possibly be even less concerned about their shareholder's welfare than say, our management, and stupid enough to flat out reject an offer this lucrative? I guess it's possible, but they'd better have one hell of a consolation prize waiting behind door #2 for their owners. If it's just a zonk, a massive shareholder lawsuit will soon follow, and the current management and BOD would be well advised to start updating their resumes. If a prize is in the offing, how will it be financed? Outsourcing search ads to GOOG, as has been rumored, doesn't seem sufficient to generate the short-term funds required to pay holders a significant one-time dividend or equivalent. In fact, any hook up with GOOG is going to face a tough time passing regulatory muster. So will YHOO take on debt to do something like that? Sell a partial ownership stake to someone else? Other? Unclear, but interesting.

Of course, this could be - and mostly likely is - just a negotiation ploy. YHOO's Board may well be resigned to being MSFT's Valentine in the final analysis, but figure they might as well hold out for chocolates and roses in addition to that $44.6B dinner originally offered (now subsequently devalued as the price of MSFT shares has dropped). If that's the case, common sense would suggest dialing down the "they're trying to steal us" rhetoric - especially in light of a 60% premium to market bid that several pundits have described as "insane", and which MSFT holders liked so much they promptly chopped $40B+ off the company's marketcap.

And what's Ballmer's next move upon a formal rejection? Now that he has opened this veritable Pandora's box, in the process destroying that aforementioned MSFT shareholder value, is he going to simply shut the lid and walk away? Sorry folks, early April Fools' joke? While that's likely best for MSFT holders, certainly short-term, it's not likely to enhance his credibility - and he isn't exactly swimming in an abundance to begin with. Will he choose to turn it upside down and shake it instead, bypassing YHOO management altogether and going directly to shareholders - a true hostile takeover that drags on for months? That'll help the stock price. Not! Or will he try to appease the evil spirits, order up those chocolates and roses (and, at the rumored $40 price, dessert wine, a fur stole, a diamond ring, etc.), and just add it to our tab? Capital Research no doubt had something to say about that one - thank God. But I suspect that Ballmer will still bring the offer back up to the at least the original $31 valuation, and will probably go another 10-15% above that.

As a sanity check - or more accurately insanity check - if he ends up going all the way to $40, the deal would now be worth ~$53.6B. Not counting the additional billions here or there in advisor fees and other miscellaneous transaction costs, that would result in the originally envisioned (and abusively dilutive) "600M" of newly minted MSFT shares swelling to ~938M+ - or almost a 10% overall dilution. And we didn't even get the chocolates, roses and dinner first...

I have a better idea. Let's get someone to see the value in MSFT that Ballmer has kept so well hidden these past 8 years, and offer us a 60% premium. Given Friday's close, that would put us at $45.69 - or just about 20% down from where we were when Ballmer first took over as CEO in '00. Surely someone would like us to be their Valentine? We aren't cheap, but we have redeeming virtues. And we won't be ungrateful and accuse you of trying to "steal" us.

Update:

It's official, YHOO has rejected the offer as too low:

Yahoo Rejects Microsoft Bid, Leaves Room for Further Talks

(though they did dial down the rhetoric from that used in the weekend's convenient advance leak).

Some numbers and background on what YHOO is really worth courtesy of Henry Blodget:

Sorry, But $31 Does Not "Massively Undervalue" Yahoo

(The range btw is $21-$26, and that's using optimistic numbers and assumptions. It's also on a standalone basis. As part of MSFT, YHOO's results would enjoy MSFT's multiple. For example, "35X 2009 estimated EPS = $26", would become "16* 2009 estimated EPS = $11.88" using MSFT's current multiple - give or take any "synergies", of course. Recall what I said in an earlier post about an eventual $1-$2/share goodwill write down for MSFT if this deal goes through? Now you see how that could result)

Not surprisingly, MSFT is selling off further on the news. Consensus expectation appears to be that MSFT will make a higher counter offer - at least before trying other more aggressive measures. In other words, dig in - it's going to be a while, and the stock is going lower before it's done.

Update #2:

MSFT officially responds:

Microsoft Responds to Yahoo! Announcement

("Good" news? Not upping the original offer, despite the subsequent devaluation - to around $29 and change for each share of YHOO. Bad news? Still want the deal. Read: will likely do so eventually)

Also worth a read:

Microsoft: Yahoo’s Response To Offer Is “Unfortunate;” Warns It Could Take Other Steps; No New Bid

Excerpt:

Concludes Havens: “It’s not a question of whether they will be acquired, but at what price, and how long will it take.”

Media Roundup

2008-02-07T16:47:00.001-08:00

1) Mark Cuban wades in:

Why Yahoo should say Yes to MicroSoft

(I respect Cuban, but he must not own MSFT shares)

2) Review of various integration scenarios:

How To Put Together MicroHoo

(#1 role model: HP/Compaq. Um, didn't that one initially screw up so badly that the stock nosedived and the original CEO got the boot? On second thought...)

3) Others, besides YHOO's owners, who stand to make a killing:

Microsoft, Yahoo bankers eye $1 billion payday

(MSFT shareholders get to supply the blood)

4) An absolutely scathing review of MSFT:

No joy for Microsoft shareholders in Yahoo

Excerpt (bolding mine):

Ask investors what they think of Microsoft's innovative juices. The company's stock market value is huge – $280-billion (U.S.) – but it goes for 15 times earnings. Compare that to a far less profitable information company like Thomson Corp., which has no true monopolies (and is a part-owner of this newspaper). At a 10th the market cap, Thomson changes hands for 21 times forward earnings.

Why? We would argue that it's at least in part because Thomson is much more careful with shareholders' money. Thomson investors are rarely diluted by acquisitions or by squandered investments. It's hard to argue with millions of investors.

(Hmm..less "careful with shareholder money"? √ Constantly diluting us by "acquisitions or by squandered investments"? √√ Arguing with millions of investors? √√√).

5) The most succinct but insightful comment I've seen yet on this market space. Ballmer would be well advised to pay attention to the same input:

Yahoo Vet Millard: Microsoft Deal Was "Inevitable" (MSFT, YHOO, MSO)

Excerpt (bolding mine):

Yahoo lost sight of who they are and who their customers are. Yahoo's perception is that their only competitor is Google. But 95 percent of their revenue comes from advertising -- so their competitors are really the broadcast TV networks. They think they're in the search game,when they should really be in the brand advertising game.

(Oh, and hire this person)

6) Analyst Trip Chowdry provides some comic relief with a fantasy conspiracy theory worthy of Oliver Stone:

Analyst: Microsoft's Yahoo bid may be fake

(If only Ballmer were that strategic and cunning. He's neither.)

7) The sad reality:

Analyst: 70% Chance For MSFT-YHOO Deal

(Near 100% chance MSFT shareholders lose money either way though)

8) Finally, the no-brainer trade now that MSFT management have effectively told us they've revisited the future and that what appeared to be incredibly bright initially, turned out to be just the approaching headlights of a Mack truck traveling full tilt with glamour tags reading:

GOOG

(Cue sound of air horn)

Meanwhile, another selloff for MSFT on 2X average daily volume:

Update:

Worth a read...

An Open Letter to Steve Ballmer

Excerpt:

I know you want to make your mark on Microsoft, but you should stop trying to be all things to all people. Take a tip on focus from that other Steve.

Dear Steve,

Let's talk over this Yahoo! (YHOO) thing before you move ahead. It's a profoundly bad idea.

Also:

Another Reason MSFT Won't Raise YHOO Offer: Capital Research

(Some possibly good news here. Especially since Capital Research is the largest institutional shareholder of both companies, and therefore has much more potentially at risk on the MSFT side)

Update #2:

More... um, "praise" for the deal:

Would buying Yahoo be a mistake for Microsoft?

Excerpt:

He is especially frustrated by Gates's pursuit of his white whale when Microsoft has bigger fish to fry, like parrying the challenge from free operating systems like Linux; adapting to the migration of computing from the desktop to the cloud, and competing with Apple as it insinuates its hardware and software into people's living rooms, cars and telephones....

"Just now, when they've got momentum, they're going to crush it with this terrible deal," Mowrey said. "I think Microsoft is worth a lot less today than I thought it was worth yesterday."

Shareholders Want Microsoft-Yahoo Deal Done -- Pronto

Excerpt:

"This is totally insane," says Shareholder Value Management analyst Jeff Embersits. "There's no way Yahoo's worth $44 billion. Period. [Yahoo Management] should fall on their knees, kiss the ground and go home and buy Porsches."

("Insane" seems to be popping up a lot when describing this deal.)

Having Fun Yet?

2008-02-06T11:50:00.001-08:00

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.

Update:

Is Microsoft Desperately Seeking Yahoo?

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.

"This is like a person who's completely lost his mind"

2008-02-05T08:40:00.001-08:00

That's Joe Rosenberg's take on MSFT's bid for YHOO (Rosenberg is Chief Equity Strategist for Lowe's Corp., a major Wall Street heavy hitter, and MSFT shareholder). Close, Joe. It's not like that, it is that. Rosenberg continues:

It's absurd. They're not going to earn anything like a reasonable rate of return on their investment in Yahoo. It just doesn't make sense.

This deal would do more harm to Microsoft shareholders than any of its competitors can do to it," Rosenberg said. "The company has lost sight of its principal focus, which is to produce value for shareholders."

Hmm...I believe I may have mentioned that last part a gazillion times or so over the past few years.

Meanwhile, Ballmer and Liddell are busy talking up the synergies of this deal. "Synergies", btw, are what you point to when you can't provide any specific, reasonable, measurable basis under which this deal makes financial sense, especially for MSFT shareholders (otoh, YHOO ones make out like bandits).

As someone who has repeatedly called for MSFT to reduce its at times chronic overcapitalization and use that money to make smart, accretive acquisitions or return it to shareholders, I'm obviously not against them doing either per se. But if you're going to go the acquisition route, note the qualifiers: smart and accretive. Buying YHOO, imo, is neither. The company already agrees that it isn't the latter - at least not for two full fiscal years following a successful purchase, and even then "excludes a lot of the accounting and purchase accounting of one-off costs".

Ballmer is touting this deal as building on the successful momentum that Online has been able to generate. Huh? This deal is about failure, not momentum. Failure to spot the potential of this market space back in the late 90's. Failure to respond for YEARS while others staked out their now dominant positions. And failure over the past 4 years, since the company got "serious" about it, and spent $10B's directly (and likely at least that much again in R&D) in a failed attempt to catch up - or even generate a profit. Meanwhile, we have the failure of his previous massively expensive "emerging" bets to be anywhere near as attractive, or even to collectively payoff.

Then there's the issue of credibility. Why should we believe anything coming from the team responsible for that track record of successive failure, who initially said catching up would be a matter of 6-12 months (how'd that work out?), or who recently justified $6B more of our money going to buy AQNT by assuring us that most of the big pieces were now in place for success?

On the timing front, why now when MSFT was finally showing some organic business strength and attracting investors? In a heartbeat, perception of MSFT has gone from potential comeback kid to looking even more desperate and ineffective than ever versus GOOG. And on a more macro basis, why do this with the economy sliding into recession, with many forecasting an extended bear market, when GOOG is experiencing their first major revenue and earnings miss (finally beginning a process of unwinding their - and most related company's - higher multiples), and consumer-facing entities in particular are likely to be hard hit? Was YHOO secretly getting stronger and more valuable despite their recent grim earnings call, layoff announcements, and nosediving stock price?

And what about valuation, a whopping 60% premium to market bid - some 66X earnings - for a company already trading at 2X the PE of MSFT and expected to actually shrink earnings next year despite operating in one of the industry's fastest growing segments? And given GOOG's miss the night before, YHOO was poised to drop significantly further on Friday. So then the real premium would have been more like 70%.

Then there's the impact on MSFT shareholders. You know, the folks who actually own this company? With $40's looking possible (assuming a better market) on the back of some long-awaited business improvement and stock momentum, why should we want to see that destroyed via an acquisition that negatively impacts EPS for at least FY 09, and probably FY 10 as well? Not to mention adds tremendous additional risk, uncertainty, etc. in the interim? Similarly, why would we want to see the past $20B+ of buybacks using our cash instantly reversed, thereby diluting our ownership interest all over again? If this really is worth betting the farm - which is what Ballmer has effectively done - why not make it an all cash offer like every other recent one? The company now says it plans to take on debt for the first time anyway to finance this deal, so that historical excuse no longer flies. And Ballmer's answer yesterday - that he wanted to avoid financial risk (in addition to market and technology risk) - is hogwash. MSFT could easily make this an all cash offer, take on debt to fund the part not covered by cash, and then suspend the existing buybacks for the next couple of years to pay down the debt (or do just enough to neutralize normal ongoing dilution). There'd even be a beneficial tax writeoff. And YHOO has several equity interests that could be spun off in the interim to recoup at least another $10B (though you have to approach that carefully since the Chinese Alibaba stake in particular could be long term attractive). But instead, Ballmer et al plan to do what they always do: let Mikey - aka the average MSFT shareholder - eat it. Well, actually another orifice is involved...

And what about the business logic? Do two GOOG roadkill equal one GOOG killer? If not, is distant #2 sufficient to justify this investment over any reasonable timeframe? Or is it reliant on some asinine 1-2 decade payback period like say Xbox, or maybe 2-3 like IPTV? Are current MSFT/YHOO customers going to say, "Wow, this disruption and uncertainly has me really excited. I'm not going to jump ship to GOOG and simply watch and wait. Instead, I'm going to stick with you though the next couple of years of integration nightmares, false starts and confusion"? Are current GOOG customers going to say "I bet MSFT can integrate both entities and still do a better job for me than GOOG does currently. Sign me up"? Are YHOO's predominantly Silicon Valley/BSD/Open Source/Open System orientated leadership and engineers going to sit back and say "Thank God MSFT came to our rescue. I've always admired them so much, and can hardly wait to start taking orders from Redmond and being told to switch to their proprietary technology, versus simply walking down the block to XYZ tech leader or startup"? And who's going to do the major personnel cuts required to give this merger any chance of success? Ballmer, under whose leadership MSFT has turned into a top heavy, slow-moving, bloated bureaucracy? Is he suddenly going to reinvent himself as Al "Chainsaw" Dunlap and lop off 5000 plus employees minimum? What about the obvious duplication across almost every area? How do you consolidate effectively when you're primarily after the user base? Some pundits are saying "they'll just pick technology winners" in each category. Excellent. So if I'm the guy who was using YHOO mail, and MSFT selects Live Hotmail (or whatever it's being called this particular week) instead, they figure I'll just happily accept it? Are they frigtarded? In almost all the major areas, users either consciously or unconsciously made a choice. If you attempt to remove that choice, there will be pushback and defections. The most likely beneficiary of that is GOOG.

I also find myself getting reflective, and noting that with this move Ballmer will have blown through the entire cash pile that once reached ~$70B - and even taken on debt for the first time in MSFT history - while some competitors have invested far less (directly and via ongoing R&D) and yet now enjoy cash balances not far off MSFT's. What has been accomplished for all that cash and ongoing R&D investment? Is MSFT stronger? Are shareholders better off? Are customers happier? Are employees more motivated? Are the core products better thought of? What about the impact of this move on MSFT's existing businesses? You know, the ones they've done such a great job running to date that the banner "We uninstall Vista" is a differentiator for some PC shops, OS X continues to gain share, SQL Server just got delayed again, IE continues to lose dominance to Firefox, Nintendo continues to dominate and PS3 is threatening to finally outsell Xbox this past month (for the first time), the flash Zunes just got a quiet price drop (no doubt due to very poor sales), IPTV is still a non-factor to MSFT's overall results despite more than a decade and $10B's invested, etc. etc. etc. Are those areas going to get more or even less focus as MSFT goes further afield from its supposed core competence, vainly battling GOOG head-to-head? And what if the cash cows need to buy someone? With no cash left, does that mean MSFT goes further into debt? Or do they go without, while Online loses some more money for us?

I've discussed the concerns. Could this biggest of reckless big bets pay off? Sure, there's an outside chance it could succeed given a long enough timeframe (read decades), uncharacteristically brilliant MSFT execution, and GOOG somehow fumbling. Is that reason enough to do it? No. Were it $20-$30B, my answer might be different. Everything has value assuming the right price. More importantly, I'm getting really tired of "promising" emerging opportunities being turned into financial sinkholes by leadership's "strategies", and then being forced to underwrite desperate fourth quarter Hail Mary passes with either our cash or via dilution of our ownership (while comically hearing that there's still plenty of time left on the clock), all for the promise of a future touchdown which never materializes. MSFT shareholders are constantly being asked to underwrite massive investments for some future payoff, only to be told (when that future arrives) that the payoff is delayed and still more investments are required.

Here's how Ballmer sums up this deal:

We have been losing money. Our plan here would be to not lose money in the future

Shareholders who have held MSFT stock since he took over as CEO in 2000, are faced with the same dilemma. Maybe that's why so many are selling on this news. The rest should be hoping that this deal gets kiboshed - either by YHOO or via regulators.

Update:

Microsoft: $250M Here, $6B There, $44 Billion…

Excerpt:

A quick way to destroy my valuation target, not to mention the perception that you are a good company, is to go and throw your cash at a crappy acquisition target, paying 40x FCF in the process – and this is coming from someone who stuck up for Microsoft’s aQuantive and Facebook deals. Maybe this is all part of a brilliant plan on Microsoft’s part, but all I see is a massive expenditure of capital into a non-core industry where the company has no track record of success.

Q2 FY08 Earnings

2008-01-24T10:05:00.001-08:00

Preview:

Stakes heading into MSFT's report are about as high as I can remember. The punishment for companies who disappoint this earnings season has been swift and severe - just ask INTC or AAPL holders. Additionally, you have markets that are on the edge of the abyss. At the lows yesterday, the Nasdaq notched the 20% decline that signals a bear market - and the Dow and S&P weren't far behind. Luckily, buyers waded in and the subsequent rally managed to turn it into a reversal day. But signs increasingly point to the demise of the bull market that began back in 2002.

For its part, MSFT has held up amazingly well during this market meltdown. Although significantly off its recent highs, it's substantially above the $28.60 or so level it would be at had it just performed like usual (i.e. at or below the index). The risk, of course, is that we'll end up there shortly if the market takes exception to anything said tonight. Alternatively, if MSFT impresses, maybe we rally a buck and give the rest of tech at least a short term boost as well.

As a reminder, consensus is as follows:

Revenue: $15.95B
EPS: .46

See more background here:

Microsoft expected to post sharp profit rise

The most important figure - guidance for the year - was:

Revenue: $58.8B-$59.7B
EPS: $1.78-$1.81

If MSFT backs away from that at all, we're done. Q3 compares are also going to be ugly given the benefit realized last year from the deferred Windows and Office revenue. As per usual, if the market likes the report and guidance overall, then what is primarily an accounting/timing issue will be given a pass. Otherwise, we'll see headline after headline tomorrow about "slowing growth". FWIW, Goldman is banging the drum and getting "conviction" about MSFT again ahead of earnings. They called it right last time, although their conviction was short-lived - more like an infatuation. So let's see if [newer] analyst Sarah Friar can make it 2:2, following Rick Sherlund's disastrous 0:30 record previously.

I'll be back after earnings to update this post. Meanwhile, you can check out the recent Motley Fool bull versus bear debate on MSFT, or join me in scratching your head over this development.

Results:

Very strong. Looks to be a beat of consensus and whisper numbers on both the top and bottom lines, along with raised guidance for the full year:

Revenue: $16.37B
EPS: .50

Guidance for the year:

Revenue: $59.9B-$60.5B
EPS: $1.85-$1.88

Stock is up $1.50 to $34.75 currently in AH. Back with more commentary after the cc.

Conference Call and 10Q analysis:

15% growth overall (net of technology guarantee impact)
$4.1B in buybacks during the Q (leaving $8.7B remaining on the previously approved $36.2B)
Online advertising growth of 38% (26% excluding AQNT)
Online expenses grew even faster though
E&D managed its third ever quarterly profit and first back to back one (now just $5.4B to go before breakeven)
Cost of revenue dropped from 29% to 22% during the Q (yielding 21% vs 23% YOY half way through the fiscal)
Result: operating margins increased 4% to 40%
SharePoint grew 50% during the Q, as did Office Communication Server
Dynamics customer billings up 26%
427M Windows Live ids from 352M last year
22nd consecutive quarter of double-digit revenue growth for Server & Tools (very impressive)
Over 60% of sales from users and regions outside of the US (emerging markets up nearly 30%, non-US mature up 20%)
Unearned revenue down sequentially, but up YOY ($12.178B vs $11.861B) and $500M more than forecast
R&D up 15% on the Q to $1.885B from $1.637B, but down a point as a percentage of revenue (and no, I'm no clearer on the value received for money spent)
Cash + short term investment down to $21.1B from $23.4B
Expect PC growth for the year to be 11-13% now (up 1% from previous)
Diluted shares outstanding decreased to 9.503B from 9.942B
Total stockholder's equity up $3.33B to $34.431B
Not immune to global economic factors, but haven't seen any negative spillover from a weakened US economy (yet)
Currently under audit by the IRS for tax years 2000-2006? (I must have missed this one previously)

Short version: strong results, increased guidance, generally upbeat tone, and no really embarrassing items for analysts to question. Good job! Yes, online continues to be a sinkhole for cash. But everyone is used to that by now, and at least the top line result is semi-respectable. Yes, there's still no color on actual large scale Vista deployments. But at least client revenue and unearned remains solid. Bottom line, if last report was sufficient to get some investors to take another look at MSFT, then this one should attract others and perhaps reduce doubts that last time was merely a fluke.

Stock now up $1.59 to $34.84 in AH. We'll see what happens tomorrow in the regular session.

Update:

Mini has a good selection of the post earnings reviews that I normally provide here. So I won't bother duplicating that, although I'll offer one more just because I like the title:

Microsoft Knocks "Financial Cover" Off The Ball

On the less-positive but still worth reading side, Henry Blodget drills into the online numbers further:

Microsoft's Online Division: Flat Growth Rate, Still Burning Cash

For its part, the stock opened strongly ($34.90) but has given back much of that gain currently ($33.54). Volume is very high (already surpassed average daily volume).

And then there was one...

2008-01-10T18:08:00.001-08:00

Jeff Raikes retires from MSFT.

My initial reaction - "Wow!". Didn't see this one coming. Gates, Ballmer, and Raikes have effectively been the top echelon of the company for as long as I can remember. With Gates having already announced his retirement this year, and now Raikes as well, that leaves just Ballmer from the original troika.

The [external] choice for Raikes' replacement seems to have the right pedigree. There is also a fairly decent transition period - so hopefully no balls get dropped in the process. But Raikes did a solid job with Office and was widely seen as the leading candidate to succeed Ballmer. So combine that with some other recent high level departures, and I don't think the market is going to respond positively to the news tomorrow.

Some coverage:

Update: Made some additions/deletions.

Update #2 (1/11/08): Additional coverage that caught my eye:

Raikes reflects on 26-year run at Microsoft
Raikes to Follow Gates Out the Door
Office man to exit Microsoft

"I don't have CEO envy," he said. "I like the kind of role that I play in the business. The key thing is Steve's a tremendous leader of our company and he's made it clear that he wants to be CEO here for many, many years — maybe 10 years or more — and I think that's great. I think that's the best thing for Microsoft."

(possibly telling comment here, assuming you read between the lines?)
Analysts React to Elop’s Microsoft Defection
Elop brings strong skills to take on competitors
Juniper shares drop 15% after COO resigns to take Microsoft job (apparently someone agrees with the article above, though there was a analyst downgrade there as well).
Microsoft shuffles management in mid-year cleanse (Includes some analyst perspectives for and against the Elop choice)
The Microsoft reorg week in review (Foley details the recent senior level departures)

As someone who has been calling for leadership change for some time, I guess I'm overall happy to see it possibly occurring in earnest. But if it is (and the departure of Gates and Raikes make it unique regardless), it's almost inevitable that there will be those you didn't want to lose along the way - and ones that don't go who should. Let's hope both are minimized. It would also be nice if these announcements weren't landing so close to earnings and dribbling out piecemeal, with reports of still more departures to come. As this level, as reported, these things don't normally come as a surprise, at least for Ballmer. So make the announcements - all of them - and let employees and the market move on. That way it sounds like planned change, not musical chairs at the top or - worse - abandon ship.

Gates kills it at CES - literally

2008-01-09T14:06:00.001-08:00

So Bill Gates had his final CES keynote as a full-time MSFT employee (and likely his last ever). Anyone who has attended a Gates presentation knows that they're long on repetition and short on excitement. In fact, they're normally real groaners. But apparently some were hoping for a miracle despite that well-established track record. And given that the consumer market is red-hot right now, and MSFT - being perpetually slow to respond - has finally even acknowledged that it needs to do a better job there (earmarking $300M more for advertising), it would have been nice to see Gates and MSFT do more. But alas, it wasn't to be. In fact, the best part imo was the video - which shows a self-deprecating side of MSFT that I think few external watchers appreciate exists.

Still, the media reviews are surprisingly scathing. Which suggests to me that others besides myself are tiring of MSFT constantly promising innovation but delivering precious little of it, and are no longer afraid to say so. Some examples:

No More New Things From Microsoft

Excerpt:

In an era when the vanguard of technology is creating smart devices for entertainment and communications, Bill Gates, the outgoing chairman of Microsoft, had little that was interesting or innovative to show off in his last annual keynote at CES in Las Vegas on Sunday.

Consumer Electronics Show (CES) 2008 A SuperSite Special Report

Excerpt(s):

But the biggest problem for CES isn't the competition, it's internal. And you only need to look as far as Microsoft to see what's wrong. Despite headlining the event, Microsoft didn't make a single major announcement last night, let alone acknowledge that some of its biggest announcements from last year--Windows Vista, new Media Center Extenders, or an IPTV-based Xbox 360--have yet to materialize or have any real positive impact on the market if they have.

And for crying out loud, start talking to Steve Jobs. That the most influential consumer electronics company in the world isn't at CES is a crime.

And finally, the Pièce de résistance:

The Truth That Dare Not Speak: The CES Keynote Sucked

Excerpt:

The big question is how, in 2008, have we come to a point that Microsoft is so bereft of new ideas and innovation that what was once the most important keynote speech of the year turned out to be a complete dog? It’s not for a lack of good people, there are many in Microsoft doing a great job, and there’s even some good technology and products being created (Silverlight and Windows Live Maps being two examples) and to those people I say don’t take this personally, it’s not personal, it’s just that if people don’t have anything interesting to say, they’re better off not getting on stage and making us yawn. I’ll be in San Francisco for the Steve Jobs keynote at Macworld next week and I doubt that I’ll be writing a similar post.

"How" indeed. Current leadership should really reflect on that - especially in light of the massive R&D spend relative to virtually everyone else (especially AAPL) - and make substantive changes. Will they? Of course not. They'll simply deny it's true - call it the "Vista defense".

Reviewing the rest of the MSFT-related CES coverage, I found this article the most interesting:

It's all about software, says Gates

Primarily because of this excerpt from Gates, which encapsulates most of the reasons I continued holding MSFT:

Gates: Remember, it's all about software. So why are we talking about those companies? There are very few companies that understand software. The phone is becoming about software, the TV experience is becoming about software. Our bet goes back to the founding of the company--that software is going to be at the center (of things). It really is coming true.

I think the core of who we are and what we do (is) believing in a platform. We're better positioned than anyone. Do we have to continue to work on our advertising scale and our search and some usability things in our music products? You bet. But that all comes off the core of being a company with the best research group, by far, of any software company, and a breadth of talent that everyone is envious of.

What a shame that they've done such a poor job of executing to be the leader in realizing that vision. Instead, they lost focus, decided to be lazy, played defense, tried to solve every problem from a PC-centric perspective rather than a platform-agnostic software one, and vainly tried to hold back the internet. So now others - in particular AAPL, GOOG, and even Adobe - are realizing this original vision for them. Can this situation be turned around? With a lot of hard work and tough choices, I think so. But I don't see how you get there with a leadership team that begins from a position of near-total denial. Just ask an iPhone user who they think "understands software" better - AAPL, on their first attempt, or MSFT after nearly a decade of mobile involvement? Or maybe the problem isn't "understanding software", but more importantly understanding what people need to accomplish from it, and then maximizing the resulting "experience" for those paying the freight? Oh, and delivering on your commitments doesn't hurt either. Just a thought.

Off-topic - but related timing-wise (and therefore worth covering in this post) - is MSFT's decision to acquire Fast Search for a whopping $1.23B. I'm still scratching my head on this one. The market hated it - there's nothing like announcing a new $1.23B acquisition and immediately losing $5B in marketcap on the news. Apparently, the market initially saw it as [more] good money going after bad in the so far hopelessly losing battle against GOOG for consumer search/advertising share. That seems to be wrong, with the deal being more of a SharePoint/enterprise play. Thank god! Market reaction today suggests that maybe folks are now getting that. Still, when you the read history of Fast - suspended trading, accounting restatements, executive resignations, charges that a Director sold the company an external organization at an inflated price (pocketing the windfall), the heretofore dominant shareholder demanding removal of board members, Directors being sought for tax evasion by the Norwegian equivalent of the IRS, etc. - you really have to wonder "wtf was MSFT thinking?". Oh, and did I mention it's unprofitable? Doesn't MSFT already have too many of those?

Now, maybe Fast has some killer technology and/or people that would be worth this otherwise ridiculous premium for such a troubled company. Even then, you have to question how come MSFT R&D, which has some of the industry acknowledged superstars in Search (and has been focused on it for several years now), wasn't light years ahead of some struggling player from Norway. Quite frankly, the whole thing smacks of a defensive move by MSFT to either play catch up (which, as above, shouldn't require going external), or to ensure that a failing company with some good technology didn't fall into the hands of ORCL, IBM or perhaps GOOG. Neither option seems like an especially great use of $1.2B of our cash, unless we see R&D come down by say an equivalent amount? Yeah, didn't think so.

Some people do like the deal:

Microsoft Bids $1.2B for Norway's Fast

Excerpt:

Forrester Research analyst Ken Poore called the buyout "a big deal." In an interview, Poore said Microsoft's search strategy has been weak, leaving the software maker trailing behind not only big players like Fast, but also Oracle and IBM, who have been investing in the technology in recent years.
"By going out and acquiring Fast, in my opinion, they've kind of leapfrogged" IBM and Oracle, Poore said.

Microsoft Buys Fast, Plays Catch-Up

Excerpt:

The acquisition will give Microsoft an immediate strong presence in the market for corporate search software thanks to Fast's high-end roster of clients, including Merrill Lynch (ML), Disney (DIS), Best Buy, Pfizer (PFE), and Dell (DELL). The Norwegian company's chief rivals in the estimated $4.8 billion business include Google (GOOG), IBM (IBM), Britain's Autonomy, Oracle (ORCL), and SAP (SAP). Fast was on track to book $200 million in 2008 sales—about 20% higher than in 2007—and Microsoft's direct-sales and reseller network can expand that, UBS (UBS) analyst Heather Bellini wrote in a note to clients.

The latter includes MSFT perma-bull Brendan Barnicle, a vice-president and senior research analyst at Pacific Crest Securities:

"Buying Fast will cost Microsoft less than three weeks' worth of free cash flow, and could provide better returns on the company's $21.6 billion cash pile than stock buybacks and dividends...Microsoft has tried everything in the world with its cash," Barnicle says, "and nothing has really worked for the stock."

Um, Brendan, is that meant to encourage shareholders given that the company isn't profitable? Sorta like "buying the shares of a losing company is a better investment that buying shares of MSFT"? Er, okay. Also, isn't that because the one thing they haven't done with our cash is use it to make smart, accretive acquisitions in areas that they actually know something about and can execute best-in-class in?

Also pumping the deal was top-rated Goldman Analyst Sara Friar:

The acquisition of FAST bolsters Microsoft's positioning in the enterprise search market. We view this acquisition as a necessary next step to help Microsoft shore up its defenses against Google in the enterprise. Microsoft's strength is that it owns the entire back-end infrastructure and hence data in the enterprise, which may be more difficult for Google to access. We also believe that this acquisition highlights an increased focus on inorganic growth.

Hmm.."shore up its defenses" in the enterprise? Isn't that what MSFT's massive annual R&D spend is meant to do - at a minimum? And an "increased focus on inorganic growth"? So basically Ballmer is throwing in the towel on his largely failed "big bets" strategy and adopting ORCL's approach instead? The same one he initially denigrated, but which has subsequently shown far better returns than his own? Well, if true, that might actually be a good thing - though Fast seems an unlikely candidate for achieving success on that tact. Finally, Sara forgot to mention that Goldman acted as advisor to MSFT in the deal. But I'm sure that didn't influence her coverage <wink>

Bottom line, this was likely Gates' last keynote at CES - and that's a good thing. Listening to Bill reminds me of some old-school news anchors or politicians. They're smart, capable, etc. but just seem out-of-step and staid. Sorta like recent interviews I watched with former NBC anchor Tom Brokaw and current CNN anchor Anderson Cooper. Cooper came across as hip, fresh, and real; Brokaw did not. The company needs a new chief spokesperson. This time, one that's capable of getting people fired up about the company's new and exciting offerings (assuming they can fix what's wrong there and deliver those). And please don't tell me that's Robbie Bach, whose CES presentation sounded more like he was doing his performance review and trying to justify his job. It also isn't Ozzie, sadly. So who? And wrt the Fast acquisition, let's just say that for shareholders at least, that's yet another questionable "show me" investment versus any kind of obvious home run.

Update: Under the heading "be careful what you wish for". Okay, so maybe there's a limit to how "real" you want your main spokesperson to be after all:

Holy Crap: Did Bill Gates Just Say Windows Sucks?

The discussion here provides some more background on his thoughts wrt Vista, mistakes made, and what I hope he meant.

Will this dog ever hunt again?

2007-12-22T10:51:00.001-08:00

I haven't published anything for a couple of months, which led one commenter to wonder if I'd been "shut down". That sounded kinda ominous - sorta like black helicopters swooping down from Redmond HQ. Alas, nothing quite so dramatic. I simply haven't seen much that I thought was worthy of comment.

Not that I didn't try. In November, for example, I wrote up the annual shareholder meeting. I titled it "The Annual Transylvanian Convention" because it felt more like I was listening to management dancing the Time Warp at the Rocky Horror Picture Show. There was company leadership delivering their well-rehearsed but increasingly tired old lines, and a cast of shareholders from the lunatic fringe, including head psycho Ken Hutcherson. Had I been in attendance - versus listening to the webcast - I would definitely have sailed a piece of burnt toast in the good Reverend's general direction. Then again, my focus would have been on asking Steve:

A dollar invested the day you took over as CEO in 2000 in any of your main peers/competitors like IBM, ORCL, HPQ, SAP, and AAPL, or simply placed under a mattress, would be worth far more today that the same money invested in MSFT which is down almost 40%. Additionally, despite all the money the company has made during that time, shareholder equity has actually declined, in large part to accomplish even that anemic level of stock performance. Given that track record, why do you think shareholders should continue to support your management team, this BOD, and continue holding the stock moving forward?

I also started putting virtual pen to paper on the various "How best to structure a MSFT/YHOO deal" articles that appeared that month. But then decided that talking about "how best" to structure a MSFT/YHOO merger is really just an oxymoron. Partner? Yes. Merger? Expensive for MSFT shareholders and highly unlikely to succeed.

Anyway, I've continued to follow events and the stock. And it's not like there haven't been a ton of developments on both. WRT the former, I guess I've been struggling to decide whether the recent impressive flood of product releases (updates, SPs, betas, etc.) - gives me hope that MSFT is finally getting its act together, or whether the massively bungled ongoing clusterfuck that is Vista's launch, the continued market share hemorrhaging to Google, the embarrassing success of the iPhone (which appears to have MSFT's mobile group in full damage-control mode and doing public mea culpas about what they need to fix in their UI), etc., convinces me that this company is in a fight for its very survival - and losing. Indeed, that's why the title of this post is a question mark versus a statement one way or the other.

What does it say, for example, when you have a disconnect this big?:

"When Longhorn and the Longhorn wave of products ships, they will be great products. I have absolutely no doubt about that."

Steve Ballmer

"#1. No Wow, No How: Windows Vista

Five years in the making and this is the best Microsoft could do?"

PC World, The 15 Biggest Tech Disappointments of 2007

In fairness, Leopard and iPhone also made PC World's list. But numerous other publications have said effectively the same thing about Vista. More importantly, sales results - or lack thereof - prove it. This release has not resulted in the "2X adoption rate of XP" that management claimed it would. Indeed, it's lagging XP on an apples-to-apples compare. Now that's still a huge number in absolute terms, but it's a significant failure vs even company-provided expectations (far less market ones after five years in the making). Meanwhile Leopard, despite many widely-reported bugs, has been a blowout success for AAPL.

Quite frankly, if you compare the progression of OS X over the past decade with that of Windows, the feature set of both current offerings, then factor in that Apple has spent a fraction of what MSFT has on development and marketing, it is impossible to overstate the magnitude of how badly Microsoft has screwed up here. Effectively, MSFT has ceded its position as the clear leader in personal computer operating systems (btw, I'm obviously talking technology not marketshare - at least for now). That's the core of what this company does and is meant to be good at. In fact, if (when?) Microsoft eventually implodes and the definitive book is written to answer the question "What went wrong?", the Vista/Longhorn drama will no doubt make the top 5 list (FWIW, imo, #1 would be the sense of entitlement that permeated the company in the late 90's and caused them to think they were owed a market and could basically sit back and coast. #2 is the anti-trust loss and resulting fallout which continues to this day - itself caused by the arrogance from #1. #3 being the stupid decision to try and hold back the web vs embrace and lead it, which also led to #2. And #4 being a seemingly endless series of ill-conceived, poorly-executed, big bet "investments" that have collectively been a dismal failure).

For the record, I use Vista as my primary OS and have for some time. I would never go back to XP. As I've said before, it's not that Vista is bad, it's just not nearly good enough - and the $500M marketing campaign has been abysmal. First, you have to seriously question the judgement that said let's message this product as "the wow starts now" knowing full well (as is now clear) that there was very little wow, and that major driver and application compatibility issues existed. Someone high up was either seriously deluded, or (more likely) decided "wtf, let's try and bullshit our way to success". Has this person (or group of people) been fired? I'm guessing "no" (and yes, I know Allchin eventually got the golden parachute and divisional leadership has now changed - I don't think that covers it). Second, day-after-day we are bombarded with AAPL TV ads bashing Vista (many demonstrably misleading or false), endless media pieces containing factual inaccuracies along with calling the OS a downgrade from XP (absolutely not imo), buggy (not in my experience), bloated (okay, that's true), etc. And what do we get from Microsoft?

[Cue sound of crickets].

That's right, mostly silence. For example, I have yet to see even one Vista ad on TV - maybe I'm watching the wrong shows. But compare that to at least one each night for Apple. Is there anyone in Redmond that's actually proud of this release? Willing to stand up and make the case? Smart enough to understand that perception *is* important and that you're losing that battle big time? Anyone with even a glint of the old pit bull that would have come out with teeth bared and ripped into the endless stream of negativity with counter points, explanations, or at least corrected the more glaring inaccuracies? Well, there's at least one, but he's a pretty lonely voice and doing it personally versus officially. Instead, the company seems resigned to hyping Minwin as something "new", and using the promise of a more-streamlined future version of Windows (7) - along with an improved version of XP via a new service pack - to prevent more folks from jumping ship to OS X or Linux. Even Vista's SP1, which I'm sure many people have been working on tirelessly, is being downplayed at every opportunity by the company. It's like the company has thrown in the towel on voluntary upgrades and is content to just wait for hardware refreshes and/or the obsolescence of previous versions to force the change. That'll probably work too, but what's the impact for the next cycle? How many times can the company afford less-than-stellar releases of its flagship products? Or does the company think people should buy Vista as a transitional OS on the way to 64-bit because that's what makes sense for MSFT? If so, good luck with that approach. Netting it out, while the product isn't nearly as good at it should have been, it's much better than current perception. Blame for the latter rests squarely with MSFT who is failing to tell the story effectively.

I'm already running long, so I won't bother going into detail about the mess Microsoft has made of Search/Advertising and the $B's of shareholder cash blown. Management said to look for a turn by year-end and I was optimistic they could get there. That turn never came. Blodget sums it up nicely here. Excerpt:

Per today's numbers, Microsoft has a pathetic 7% share of the US market, down 3 points year over year. Given the hundreds of millions (billions?) Microsoft has spent on search, it is impossible to overstate how awful this is. Based on past trends, it's only going to get worse.

Despite all the advantages one could ever ask for (browser monopoly, unlimited money and R&D resources, global platform, etc) Microsoft is going nowhere but down in this market. Anyone who says differently is hallucinating.

Abstracting from all this, the real question I'm struggling with is how does a company who leads the industry in R&D spending and has this latent technology arsenal, manage to trail most peers on coming to market with anything exciting? I saw a quote recently that struck me as accurate - especially in the increasingly important consumer space:

Any sufficiently advanced technology is indistinguishable from magic.

Sir Arthur C. Clarke

IMO, this is why the iPhone is succeeding. Yes, you can make a case that much of it is derivative, but the way it's put together is innovative and has that "magic" quality for users. That's why customers wait in line. That's why demand is huge (reportedly as high as 25% of smartphone sales in the US this past Q). That's why people stop to gawk when someone pulls one out in a crowd. Where's MSFT's magic? Do they even strive for that, or are they content to simply keep promising "wow" and not delivering it? For example, check out this mixed early feedback on Hyper-V - a critically strategic product in yet another core technical area that MSFT ceded to someone else (along with marketshare leadership in this case). I realize it's beta, but why deliver it "early" (well, if you forget that the whole thing was already delayed previously) if it's this average and buggy? The public reason is to give folks a chance to try it out, blah, blah blah. I'm sure that's part of it. But you'd have to be an idiot if you think MSFT isn't doing this to try and freeze the market and check VMware's growth - a tactic that used to work for the company back in the 90's, but hasn't really worked since (not that that stops them from repeatedly trying it). And why is MSFT doing that? Well, because VMware didn't sit on their ass this past decade, and instead built a great product that solves a real customer need. As a result, they've been rewarded with a fantastic, profitable, fast-growing businesses that MSFT now covets, and which also poses a potential threat to its cash cows.

Moving on, I see that Mary Jo Foley's predictions for 2008 include a Zune phone. Is there anyone who thinks that the management team who failed on the original Zune, is failing on the current Zune (at least the flash models; Zune 80 is still TBD since MSFT can't seem to ship it in quantity), and hasn't made even a decent deposit on the $20B of shareholder cash pumped in and $6B lost on Xbox (despite being at it for most of this decade), is capable of delivering a "magical" phone? Let me spare you the suspense. If MSFT delivers a phone, it will introduce one or two nice ideas that it fails to even moderately exploit. The UI will be too confusing. It will be too big, too slow, too buggy, suffer from insufficient battery life, and will be poorly marketed. Version 2 - at least a year later - will be better, but still buggy and largely me-too or worse. Version 3 - at least three years after first launch - will finally start to be competitive. Sadly, by that point, MSFT will have burned through minimum $500M and still be losing money, whereas the market leader(s) will be profitable (probably from day one), and will have built a dominant position, leaving MSFT to struggle for 10-20% marketshare table scraps. We see this play out again and again and again and again. Indeed, the only "genius" H&E management in particular have shown, is in maintaining their aura of being MSFT's future - and retaining their jobs - in the face of what can only be described as abject failure on behalf of shareholders.

Sadly, I really don't see any of this changing until there is a change at the top that brings with it an entirely different emphasis on innovation, the minimum bar to ship, and places a far greater value on preserving/enhancing the MSFT brand name rather than continuously squandering/diminishing it by repeatedly shipping things that are half-baked and/or sub-par.

Moving on to the stock, again it's a mixed bag. After finally breaking out of the multi-year trading range, we promptly gave back much of it. This caused at least one publication to ask "What's wrong with MSFT". Luckily, I bought puts because I'd seen this movie before. We've now rebounded somewhat, and should end the year 5-10% better than the NAS. That's a nice recovery from the situation that prevailed for most of the year, and it's easy to get caught up in the euphoria of seeing mid $30's again. However, the fact is that MSFT has still badly underperformed most of its own self-selected peers over the past 5 years (only DELL has done worse):

And don't even bother adding real competitors and current momentum favorites like AAPL or GOOG, who again left MSFT in the dust on the year despite massively outperforming it already over the past five.

Equally concerning, is the fact that MSFT is one of the few companies on this list who have actually shed shareholder equity over that time versus grown it. Yes, the massively stupid one-time dividend (and all subsequent dividends) is part of that. Ditto the ongoing buybacks. But a big part is the unbelievably expensive "emerging bets" that have collectively failed to pay off. Add it up, and you have the current situation where shareholder equity continues to decline and a stock that has badly underperformed over the past five years. Meanwhile, outside of Ballmer and Gates, you have one of the highest paid leadership teams in the industry. Now, does that make any sense whatsoever? I'm talking from a shareholder's perspective, btw - clearly management is making out nicely despite their demonstrated failure to create shareholder value.

Bottom line on the stock, while it may be less overvalued than some on say a DCF basis, unless the company can generate some surprises on earnings and/or execution, it's likely to continue being an industry laggard and struggling to keep up with the market (although it's done better on the latter these past two years). Which is why you have comical stuff like CFO Liddell quoted recently saying (about the share price) that:

I never make a judgment about whether it's too high or too low.

WTF? The guy principally tasked with doing $B's every quarter in buybacks - using our cash - isn't making a judgement about whether the stock price it too high or too low? So are you admitting to being incompetent, Chris, or are you "just" lying? It's the latter, of course. What Liddell really means is that management want to continue abdicating responsibility for the stock - unless of course it happens to go up (in which case they'll be the first to take credit - as they comically did when the stock finally "outperformed" last fiscal, following the crash to 3-year lows the year previous caused by their bungled "spending surprise"). He's also telling you that they plan on buying it back regardless of inherent value because...well, because they're too clueless to redeploy the cash more effectively and need to keep mitigating the dilution caused by their outsized pay packages. And since we shareholders keep letting them, why not?

All of which reminds me of a statement made by a shareholder at the November meeting. Excerpt:

But Tuesday's shareholders meeting didn't have the spark longtime investors remember from the good old days.

"When I used to go to Microsoft meetings, it was like, 'Thank you, you made me a millionaire,' " said James Arnstein of Vancouver, Wash., who was attending his first shareholders meeting since 2000. "The room was just so powerful because you created so much wealth for the shareholders."

That's because back then this dog could hunt. Now, it mostly likes to eat, lie on the porch, and sleep a lot, while shareholders make corporate officers millionaires and underwrite the cost via stock declines and underperformance due in large part to the failure of said management's investment choices, execution, and ability to instill confidence on Wall Street.

So what does the future hold? Can this dog learn to hunt again? That's likely the minimum requirement for this stock to ever provide outsized returns. It may even be required for the company just to survive. Or will MSFT continue its march into irrelevance, struggling to even be an "IBM" ten years from now?

IMO, unsurprisingly, that's going to come down to leadership. Can Ballmer pull it off? I'm doubtful - he's had eight years so far and we've seen the results. Who does that leave? Raikes? He'd seemingly get the nod if Ballmer and Gates have a say, and it's likely the main reason he's stuck around. Is he up to the task? Again, I doubt it. He's simply too invested in what used to work but no longer does. Who does that leave? One of the hip earring-adorned geniuses from H&E that can't figure out basic ROI? Pass, thanks. One of the former CEO's from companies MSFT has acquired like AQNT? That strikes me as the best choice - or of course an outsider. The problem? I don't seen any signs that Ballmer is planning on giving up his chair.

The bottom line is that I really don't know how it will turn out. Even though this post (on re-reading it) comes off clearly in the negative camp, in reality I think the odds are about equal for it to go either way. What do you think? See any reasons to be more optimistic? Pessimistic? I do know one thing: If management plans to go another five years enriching themselves and letting the cost of their failed strategies and execution be underwritten by shareholders, then this holder won't be along for another ride.

Update: Further to the discussion of putting out stuff that's half-baked:

Serious Windows Home Server concerns

Some of the products causing problems?:

Windows Vista Photo Gallery
Windows Live Photo Gallery
Microsoft Office OneNote 2007
Microsoft Office OneNote 2003
Microsoft Office Outlook 2007
Microsoft Money 2007
SyncToy 2.0 Beta

But hey, why would MSFT have thoroughly tested at least those, right?

Update #2: And to give the "pro" side equal billing (although it contains some comments that make even my criticisms look tame):

Analysts Predict a Better 2008 for Microsoft

Update #3: More related articles:

Defending Windows Vista
Windows Vista gets pounded in year-end recaps
Microsoft’s $300 million ‘consumer product blitz’ inches closer (Go figure. Excerpt: "Microsoft has nowhere to go but up with any kind of consumer advertising campaign". Well that's true).
Tech train wrecks in 2007
Christmas Present For Apple Bulls: Mac Cleared for Takeoff
Apples For The Army
Apple trades at $200 for first time
Microsoft (MSFT): Skip the Vista Upgrade, Buy the Stock? (btw, it's a tease - the answer is only if you want market performance or slightly better over the next 2 years).
2008: Definitive, Unsolicited Advice for Microsoft

What a difference a week makes

2007-10-31T15:34:00.001-07:00

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:

Microsoft looks to a world beyond Windows
Microsoft Can Still Get Better
Microsoft Must Kill Google, Now [how can you resist with a title like that?]

Also, a useful earnings table that I came across:

Q1/08 Earnings

2007-10-25T08:43:00.001-07:00

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... :-)]

Results:

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.

Negatives:

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:

Microsoft: Next Stop, $40?

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.

What if Microsoft wasn't a screwup?

2007-10-20T11:16:00.001-07:00

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...

Microsoft slips Dynamics NAV 5.1 to 2H2008

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:

Leopard: Faster, Easier Than 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...

Change, or more of the same? It's up to YOU.

2007-09-22T18:32:00.001-07:00

It's proxy season again. And thanks to new corporate compensation rules, you'll find more detail than ever in this year's document. For example, you'll learn that while CEO Steve Ballmer may have been unable to get the trains to run on time, invest in areas that actually return a profit, catch major new trends, restore confidence, or get this moribund stock moving despite record buybacks using our cash, he was paid less than most CEOs to do it. The Board, in their collective wisdom, think that constitutes being "underpaid". I think it proves the old adage "you get what you pay for".

The proxy also gives the deepest glimpse yet into the mysterious formulas and metrics which underpin the so-called Shared Performance Stock Award (SPSA), indelicately referred to as the "executive feeding trough" from time to time by a certain shareholder blogger. In particular, you'll learn that senior most leadership walked away with millions each, because the company aims to pay "above the median" for such top talent (read: way above). However, that was only half what they could have received. The Board, you see, may sit idly by as you and I continue to lose money on our investment. But they want you to know they're no pushover:

We were satisfied with our performance in product acceptance and SMSG and MBD financial metrics. Our performance in customer satisfaction, while steady, and Internet searches, while growing, fell short of our challenging goals, and we were not satisfied with our performance in EDD financial metrics.

BTW, that last one is a euphemism for "even we understand that we can't be seen to condone another $1B loss of shareholder cash - on top of the mind-blowing $5B lost so far - even though it resulted from a strategy we approved of rushing a product to market without adequate testing". Hmm...think that disappointment translated into maybe zero SPSA payout for H&E head Robbie Bach? Doesn't say. Here's my wild-ass guess: "No".

Steve and the Board also want you to know that part of the reason for the large compensation payments is too retain these key individuals. Apparently folks who collectively can't lead, execute, or inspire, are in high demand. Go figure.

Along the way you'll learn that the stock price is not part of the extensive SPSA metrics. What's that line again about "you get the performance you request and reward"? However, rest assured that the general Compensation Philosophy includes this objective:

provides a significant portion of total compensation linked to achieving performance goals that we believe will create shareholder value in the near and long term

Just in case the stock being down 50% since 2000 and having badly underperformed all major indexes and most peers this entire decade has caused you to er... maybe question the value of their beliefs?

Also, be advised that the massive insider selling which has become the hallmark of MSFT post 2000 - and a frequent topic here - has now caused sufficient embarrassment that the usual "we don't comment on sales by our executives" is no longer sufficient. From now on, executive officers will be forced to keep a multiple of their salary in company stock (3-10X base pay depending on level). Doesn't that just fill you with confidence that the supposed "creme de la creme" of MSFT management need to be forced to hold this stock? And don't worry about our fearless leader Ballmer:

Because his interests are already closely aligned with shareholders’ interests...

Again, in case that wasn't as um...obvious from the stock's decade-to-date performance as it might be.

Also intriguing is what's not in the proxy. If you're a regular reader of it, you'll recall this chart which has appeared annually and compares MSFT to the S&P and NASDAQ (apologies for the image quality):

Apparently, even the extreme creativity that has been used to draw the scale historically is no longer sufficient to mask the chronic underperformance. And since reminding shareholders of how badly they've done while detailing how much management got paid for doing it is bad form - not to mention potentially career limiting - POOF!, it's gone. And with it, final abdication of responsibility by current leadership for the stock - something that's been evident for years, but is now seemingly official.

All in all, this proxy has all the spin, half-truths, non-sequiturs, outright fiction, and disdain for reader's intelligence worthy of say, a recent Vista "Momentum" press release. Since I want to be constructive, here's how we can radically improve and streamline it while also saving a few thousand trees. Instead of wasting pages and pages on excuses and justifications for lavish compensation in the face of abject failure on behalf of shareholders, simply provide us with one page containing two items:

1) A 5-year stock chart comparing MSFT to the S&P and NASDAQ indices (drawn using normal scale):

2) A clear choice:

Simple, huh?

And for all those hotshot managers whom the Board is paying millions to because they're so worried about retaining them, and who have to be forced to hold the stock, I say "quit". PLEASE. In many cases, the best possible development for Microsoft would be to have some of you go to the competition and screw them up instead. I'll happily take some less-senior person who actually still believes in the company, has vision, and can inspire others.

Alternatively, if despite the demonstrated lack of confidence you're all truly convinced that your strategies - which the street hates - are actually brilliant, then march on down to your local bank consortium and pitch them on lending you $270B (less Bill & Steve's share if they're willing to go along), plus say a 20-30% premium. Then you can buy us out and take the company private. That way, if you continue to execute as you have, it will be coming out of your dime instead of ours.

Fellow shareholders, the ball's in your court. You know which way I'm voting.

No one survives the European Inquisition

2007-09-17T09:34:00.001-07:00

Sorry to bastardize a line from Monty Python. But there's no way to sugar-coat it; MSFT got clocked in Europe today. That was a loss of staggering proportions. Where most had expected a split-decision - myself included, the Court of First Instance upheld virtually the entire EU Commission case:

The Court of First Instance essentially upholds the Commission's decision finding that Microsoft abused its dominant position," a court statement said.

As a result, the judgments on both bundling and interoperability information stand. As does the record fine. MSFT even gets to pick up 80% of the EUC's legal costs and that of several competitive rivals - or at least rival-backed lobbying groups (EUC picks up 20% of MSFT's costs). What I haven't seen covered is whether this is likely to open the floodgates to additional litigation/financial settlements with competitors in Europe (as it did in the US following the Final Judgment).

Caveat: I haven't read the detail of the Court's decision. Supposedly, MSFT will be still be allowed to improve its products. But when the court found no technical advantage to bundling Media player the way they did, you have to wonder how high the bar will be to add anything without a major fight from a further emboldened EUC. And make no mistake, they are that:

“The ruling confirms more than ever that Microsoft must comply,” said EU Competition Commissioner Neelie Kroes. “I will not tolerate continued noncompliance.”

Additionally, chances that Office and Vista - both of which are under investigation - will now be subject to further EUC demands and or charges seems like a foregone conclusion.

As readers know, I personally thought the European case was far weaker than the US one. Nevertheless, MSFT's legal team went down to total defeat. While they can still appeal to Europe's highest court, that is now restricted to much narrower rules of law only. It's TBD whether they will do so. If they're smart they won't. Which of course means...

Here's the current party line:

“I don’t want to talk about what will come next,” said Microsoft lawyer Brad Smith. “We need to read the ruling before we make any decision.”

EUC head Neelie Kroes is quoted as saying that her view of "success" [now] would be for MSFT's European marketshare to eventually drop to 50% or so. An aide later felt compelled to add that she meant "as a result of normal competitive forces". Sure.

Meanwhile, the stock is off $0.37 or 1.27% on decent but not spectacular volume (presently). The market appears to be trying to decide if this is at least short-term resolution - which they like, versus the beginning of the end for MSFT's dominant market position in Europe - which of course they don't like. Unless the US Administration brings some persuasion to bear to keep the EUC in check, MSFT - and possibly other dominant companies - are going to find it even tougher doing business in Europe. Oh well, at least we got that $0.10 dividend last week. Did you even have a chance to spend it yet?

Update: (related)

Microsoft loss is bad news for Apple, Google

and,

Harsh reaction in US to Microsoft EU antitrust ruling

Excerpt:

Thomas Barnett, head of the Justice Department's Antitrust Division, said the European Court of First Instance (CFI) in the case against the US software giant may do more harm rather good for consumers.

"Rather than helping consumers, (the decision) may have the unfortunate consequence of harming consumers by chilling innovation and discouraging competition," the US official said in a strong rebuke of the EU action.

Barnett said that in the United States, "the antitrust laws are enforced to protect consumers by protecting competition, not competitors" and that barring "demonstrable consumer harm, all companies, including dominant firms, are encouraged to compete vigorously."

Update #2 (9/19/07):

Joe Wilcox adds his two cent's worth on the potential implications of this ruling:

What Microsoft's EU Ruling Means to You

What the European Commission wants is the breakup of Microsoft without severing the business asunder.

Gives you the basic tone, if you want to save yourself the effort.

Paul Thurrott links to an interesting piece re: potential impact of this judgment for AAPL:

Time for Apple to face the music?

Update #3 (9/20/97)

Last one, I promise:

Microsoft vs. Europe

Still searching for a dividend strategy

2007-09-13T16:25:00.001-07:00

Okay, so I've posted before about MSFT's dividend strategy:

More specifically, their lack of one. I also noted in a recent post that CFO Liddell dropped some hints that led me to believe we'd see some changes:

He also seemed to foreshadow some improvement in the dividend strategy (which has been a total mess so far). Although he still expressed a preference for buybacks vs dividends.

Well, late yesterday we got MSFT's apparent first attempt at that. [note: someone might want to tell Investor Relations to update their dividend section since it still reflects the old info]. As we've come to expect from this leadership team, it was done in the usual clumsy, ineffective manner - at least if it was meant to communicate a move to a more serious, competitive, dividend strategy versus the previous hodgepodge.

The actual announcement? Another .01/Quarter increase - just like last time. That brings us to .44 annually, or 1.51% yield at the current closing price. But due to the now higher share value, that's actually a lower yield than when MSFT announced the last dividend increase (1.51% vs the then 1.54%). It's also a smaller % increase on its own. Clearly, management isn't telegraphing much confidence in the future stock price despite its depressed YTD performance.

By way of comparison, INTC's current yield is 1.77% and IBM's is 1.6%. The S&P 500 average is 1.71% (2.2% if you count just dividend-payers) and the DOW 30 average is around 2.3%. In other words, even with this increase, MSFT's dividend lags behind the S&P 500 average, the DOW 30 average, and behind some of its equivalent tech peers - as it has since inception. But the "bonus" is that you get worse-than-market stock performance too! For example, down over 2% YTD while the NAS is up more than 7%, for a total 9% relative underperformance (7%, if you want to compare to the S&P).

If you're looking for a bright spot, I guess you hang your hat on the fact that a penny still represents a 10% increase. Also, that the announcement comes in the same month as last year (versus December previously). That and the same [nominal] increase, is at least a move towards some consistency. Of course if you're cynical, you could infer that MSFT management simply decided that dividend increases are one way to placate disappointed investors ahead of the annual shareholder's meeting. Now you see the pea, now you don't...

As posted above, Liddell (at least) still professes a preference for buybacks over dividends. I'm unsure why personally, and he's never elaborated. FWIW, I'm not against buybacks per se. My problem with the MSFT variety is that for most of their life they've gone to offsetting dilution vs actually reducing shares outstanding. They've been much more effective at the latter over the past 1-2 years, but MSFT can no longer sustain that pace without further reducing cash and/or doing what some Wall St. fund managers have actually suggested: taking on debt to do even larger ones. Buybacks also have an inherent risk that management will abuse them to game EPS or prop up the stock, rather than buying because they truly believe their shares are undervalued. Not that this team would ever do that, of course. Cough, cough...

Nevertheless, you can be confident there will be more buybacks, if only to offset ongoing dilution from management/employees and the increased supply in the market caused by Gates massive ongoing sales. Hopefully, we'll also see more dividend increases and an attempt to actually be on par with at least the average, if not true peers. While some will argue that MSFT should have better things to do with their cash than pay dividends or do buybacks, I say:

1) Dividends represent a significant % of the oft-quoted historical "market" return for equities

2) MSFT is still way over capitalized and kicking off far more cash that the business requires, especially the profit centers.

3) This leadership team has shown little aptitude for making wise investments with spare cash - quite the reverse, in fact.

Bottom line, I'll take the penny per quarter increase. Thanks. Maybe shareholders will almost break even on the stock by year end now. But MSFT needs to either get a competitive strategy in place for dividends asap, or rethink why they bothered to implement a dividend in the first place. Alternatively, the leadership team can just continue to do nothing and wonder why investors aren't particularly interested in a stock that has both below-market performance and a below-market dividend.

Update: OT to this post, but worth a mention. If you've been following the media fallout on this issue today, see MSFT's response here. Didn't resolve all questions, but nicely done. Kudos to Nate and his team for putting together a timely, comprehensive explanation while still acknowledging the need to provide greater clarity in future.

Walking the walk versus talking the talk

2007-09-10T10:59:00.001-07:00

Mini-Microsoft has a very good post that reviews the recent Company Meeting. Looks like he came away happy with the content. Most interesting to me - and a seeming highlight for some others - was Steve Ballmer giving a speech where he reviewed a company scorecard:

Especially impressive was SteveB's scorecard slide where he ranked red/green/yellow how we fared against each of Linux/Oracle/IBM/Sony/Nintendo/Google/Apple/piracy etc etc, customer satisfaction, revenue, innovation, hiring, etc. I don't recall that ever happening before. In meetings past I always felt the execs sidestepped issues of consumer perception and confidence.

(via a link provided in Mini's post)

I'd blogged some time ago that MSFT needed a consistent scorecard for each business unit. It was painfully obvious from various analyst/financial community events that each group has been free to cherry-pick whatever metric they felt put them in the best light - no matter how silly that item was. So I'm encouraged that one apparently now exists. Of course mine included profitability and market share. It's unclear whether this one does. I had also suggested that each business unit be forced to report their scorecard at the Company meeting. There's nothing like the peer pressure of thousands of fellow employees/shareholders when you say, reveal that you lost another $1B and got your ass kicked by Nintendo - not that I'm singling out any group in particular, you understand. Still, it's encouraging that a consistent competitive scorecard now exists and that Ballmer et al resisted the normal urge to color all boxes green (assuming green is good).

As I posted recently, a big problem for MSFT in the investor community is its refusal to acknowledge the many, many, mistakes and failures that have occurred this decade. Former hedge-fund manager and TV personality Jim Cramer captures this external perception nicely with this:

"Microsoft, other than aQuantive, feels it's better at everything than anyone," Cramer said. "Maybe it was at one time. But that's a terrible amount of hubris to run a company with."

In my view, Ballmer's credibility would actually be enhanced by being more forthright and self-critical publicly. After all, it's not like the mistakes and failures aren't readily apparent to all. So the real concern is that management is blind to them and/or not focused on fixing them. To that end, will shareholders see the scorecard -or at least a sanitized version - along with a candid discussion at the upcoming meeting? Don't hold your breath.

Getting back to Mini's post, I took a look through the comments. While some didn't like Ballmer's speech:

SteveB speech was a big drag.

What eloquence! Several others - Mini included - apparently did. What really struck me though, were the number of comments where purported employees were still looking for Ballmer to solve the company's many problems. For example:

I loved the meeting, and now my after thoughts - if Steve Ballmer was able to get that speech plugged into the org, to get that vision to drive the company, most of all the division I work for, then he's the greatest CEO on earth (that I know of), if not, he's just a pretty good speaker.

Many of you bash Ballmer, but I wonder whether his insistence at staying is because he realizes the 4 frat boy cheerleaders he has reporting to him are paper pushers. I hope that's the case, I hope he's just waiting for someone more inspiring to show up and then turn things over.

The first one claims to be from a [former] AQNT employee. So in that case, I can understand how he/she might be missing some historical context. However, as I read these and other comments where folks are looking to Ballmer as the savior, I'm thinking "Who do they think has been CEO since 2000?". Isn't seven years long enough that maybe Steve's impact in that role should already be visible? If so, does anyone seriously think that the lack of accountability, vision, and execution that has characterized the company this entire decade is suddenly going to change? For instance, if the "4 frat boys" are just paper pushers - which btw seems excessive, who hired and/or promoted them? Why are they still around? Answer: er...Steve and er...Steve. Now the caveat here is I didn't hear Ballmer's speech, nor do I know the context. Was it a long-overdue mea culpa for himself and the leadership team? That would be constructive. Or merely an explanation of the importance/difficulty of the current strategies? In other words, more excuse-laden calls for "patience"? Other? Who knows. And what are the concrete plans for overcoming the obstacles? As one poster commented:

He mentioned a meeting with the financial analyst community a few weeks ago. If I heard him correctly, he said they asked him, "How will Microsoft succeed?". His answer left me scratching my head. He basically said (paraphrasing), “because we have to”, “we have great employees”, etc. Is that really an answer shareholders and investors want or need to hear?

I know what meeting he's referring to and that is a reasonable characterization of what Ballmer said. And no, it wasn't what shareholders and investors wanted to hear - hence the subsequent selloff.

I have mixed feelings penning this post. On the one hand, I'm happy that some employees left the meeting charged up. That's a good thing. I hate to pour cold water on it. On the other hand, unless Ballmer had an epiphany recently (or you subscribe to the "he wasn't really in charge until Gates left" scenario), logic suggests that MSFT under his leadership moving forward will be pretty much as it's been under his leadership so far this decade. Ballmer talks a good talk. He's been doing it for a long time. Sadly, results have proven that - for whatever reason - he can't walk the walk. So unless you're happy with the current status quo, real change is likely to require a new CEO.

Update: (another recap of the recent Company Meeting)

How Bill Gates Sounded in his Goodbye Speech to Microsoft

Update #2: Former COO Bob Herbold chimes in (courtesy Seattle PI's Todd Bishop). Excerpt (underline mine):

After giving other examples of how Porsche, Toyota and other large companies avoided business traps, audience member Janis Machala asked Herbold what trap Microsoft is stuck in. Herbold said that Microsoft is hiring plenty of people, but one of the big challenges is that it has not been able to launch profitable new units that complement its existing businesses. Microsoft also faces big hurdles as it attempts to transition to delivering software over the Internet, with Herbold calling it an "unnatural act" to ask 700 million people to upgrade their software through installations or buying new PCs. He said software "wants to come from a server."

Amazing how candid former execs can be after they are no longer face down in the ~~SPSA~~ feeding trough...

Wanted: Significant MSFT shareholder with a spine

2007-08-30T09:28:00.001-07:00

For some time now, I've been watching MSFT's laughable execution and downward spiral. I'm not talking about revenue, where the near-monopolies have proved strong enough that even this management team haven't been able to screw them up beyond modest growth rates. Or profits, where their anti-Midas touch has had more detrimental impact, but still not enough to throttle gains completely. I'm talking about the now almost institutionalized missed ship dates (the latest btw being Server 2008, which I believe makes for a delay on every major product release this year), largely uninspired products, endless gaffes, and of course investments that only bring losses, to name just a few.

As incredulous as I've been over this performance, I've been even more amazed by MSFT shareholders. While owners of other companies (most with far better track records than Microsoft this decade) have mounted serious campaigns to replace their leadership teams and Boards, MSFT shareholders have been largely silent. Indeed, the nascent pressure that was building for Ballmer's ouster 2-3 years ago has largely dissipated. MSFT shareholders are a binary lot, it seems. They either vote with their feet and sell (as they have for the past 5 years), or continue to hold and suffer in silence. And, of course, there's always the current leadership team telling us how super-fantastic everything is, or soon will be at least, while leading the market in insider selling. I tell you, sometimes it's enough for even me to question whether my perception of the company is accurate. But then I look at the stock price, or drop by Mini-Microsoft, and know that my view and that of the rest of the world is largely simpatico. Still, it's always nice to get corroboration. Which brings me to an article courtesy of David Hunter's Microsoft News Tracker site:

Of Microsoft, china pigs and hungry bears

Some excerpts:

In 2017, what and how big will Microsoft's major revenue streams be? Even discounting hindsight, that's a lot harder to answer than the same question ten years ago: As Vista has proven, XP is good enough: that wasn't the case for Windows 95 or NT.

Check.

So Microsoft is a huge company with a fuzzy future. In many respects, it's underperforming, if not stalled.

Double check.

The company has huge stockpiles of cash, no debt, an enormous and predictable cash flow – and almost entirely stagnant growth prospects. It's got so much money it can lose tens of billions on a new project like the Xbox, and still keep the thing going. It can take five years to produce an update when its competitors are doing it every six months, and nobody cares. It has one mode of operation, and that's to charge ahead like a stegosaurus: its upper management, plentiful enough by themselves to populate an entire Jurassic landscape, rarely show signs of evolved thinking. When was the last time Microsoft surprised you with an unexpected sparkle of intelligence?

Triple Check, although I strongly disagree with the "almost entirely stagnant growth prospects". At the risk of being overly simplistic, if you find new and innovative ways to save customers money, make them more competitive, or even entertain them, you can sell them more and grow nicely. If you largely sit on your ass and subject them to wave after wave of often marginal upgrades out of some delusional sense of entitlement, you can't. Is the former easy? No. Is it possible and routinely done by others? Yes. Oh, and for me it was sometime in the late 1990's for that question at the end there.

There are huge savings possible by culling management and R&D, neither of whom seem to have the slightest positive effect on sales or products.

Quadruple check, although maybe "slightest" is too strong. More accurate, imo, is that both have had wholly insufficient impact to justify their considerable cost.

Anyway, by now you're getting his drift. Or possibly think he's me, only far more concise and eloquent. He even states the scenario that I've posted here repeatedly:

There is no way that the current state of Microsoft is the answer to any question concerning the sensible use of the resources within the company, and the massive inertia it possesses can only protect it for so long: either outside pressures will overwhelm it, or it'll collapse under the weight of its own contradictions.

Sadly, I continue to fear that collapse (or at least several missed financial quarters) will be the eventual spark for change - and then even more people (employees and shareholders) are going to get hurt, and it may well be too late. But fwiw, the author (Rupert Goodwins) is more optimistic. He thinks a change is on the near-term horizon:

This is the weather for a coup, whether by a posse of external shareholders with inside support or a rebel group of managers with help from the investors. The trigger point isn't far away – we're nearing the end of the multi-year transition period that's seeing Ray Ozzie and Craig Mundie replace Bill Gates. By now, the changes in Microsoft should be visible – but it's not looking that good.

The "rebel group of managers" willing to back away from the SPSA feeding trough long enough to finally do the right thing for the company and shareholders, sounds like a tall order. A "posse of external shareholders" seems a lot more likely, but right now there's no obvious sheriff - or posse. A third option would be a former MSFT manager with external shareholder backing. Someone like Brad Silverberg, for example, who was right about the web when Gates and Ballmer were wrong and is no longer there because of it. But lately he's been praising them. Or maybe he's just laying the groundwork for an impending return :-)

David Hunter notes this concern at the end of his post:

It is certainly possible, but who is going to step forward to lead the charge?

Excellent question. Where is our Eric Jackson, the shareholder who successfully led the charge for YHOO's CEO departure and is now going after Motorola? Where is the person responsible for say, Capital Research & Management Company's 530,043,392 shares held in MSFT? Why isn't he/she front and center raising concerns about their chronically underperforming investment? Or do they have to carry that much MSFT just to mimic the indexes in their funds? What about CalPERS? They're normally not shy about calling out an ineffective management team. Is MSFT somehow the only large cap they don't own a decent chunk of? Does anyone think Gates' own personal investment vehicle, Cascade Investment LLC, would sit idly by through five years of market underperformance and a flat-lined stock? If so, you've obviously forgotten how quickly they made their concerns known to Six Flags management when they were displeased with the latter's execution. So where are all the Cascade-like equivalents that own this underperforming stock and company? Why aren't ANY of them visibly making their concerns known? Surely there's one money-manager out there that has his/her own money at risk, and/or actually believes in their duty to investors to ensure management accountability and performance in the companies in which they invest? Someone with some clout and a backbone? We just need one...

Update:

TheStreet.com TV Recap: Sifting Through Microsoft Rumor Mill

Excerpts:

Cramer said Microsoft is "so IBM in 1988, it's frightening ... they think they're a nimble growth company."
and,
"Microsoft, other than aQuantive, feels it's better at everything than anyone," Cramer said. "Maybe it was at one time. But that's a terrible amount of hubris to run a company with."

Home runs, base hits, virtual aspirations and actual failure

2007-08-21T11:03:00.001-07:00

As shareholders we all want MSFT's "investments" to pay off. The company obviously can't live on just its legacy cash cows forever. New accretive investments offer the potential for not just keeping the company strong, but also [finally] accelerating earnings.

Unfortunately, as per my last post, most haven't over the past decade. Sure, they've taken the up-front cash required by most investments - way more than most in fact. It's that niggling little thing called profit, or shareholder value created, that's proven elusive for the current leadership team. Which is why we now get CFO Liddell belatedly telling us that we shouldn't look for normal internal rates of return from these efforts like at other companies. MSFT "investments", you see, are special. They don't follow normal convention. Instead, they are "winners-take-all" events. MSFT is swinging for the fences; They're not interested in mere base hits. And all those apparent strikeouts so far? Well, they're hoping the game goes into extra innings.

Let's examine how this has worked out in just one area - virtualization. Back in 2003, in a uncharacteristically non-laggard move, MSFT bought the virtualization guts from Connectix. Since that time, they've done what they often do after making an acquisition: buried it in bureaucracy, forced it to be a cog in some massive overall strategic architecture plan, and continued pouring cash into it. The result? According to Trip Chowdhry, senior software analyst at Global Equities Research:

The Redmond, Wash.-based software giant has 'been a total failure when it comes to virtualization'.

Tell us what you really think, Trip. Sadly, that's accurate.

Meanwhile, EMC was busy buying a small software company. When asked about it now, they indicate that their go-in expectations were rather modest; They were just looking for a base hit. That company was VMware, acquired by EMC back in 2004 for $625M. On August 14th, 2007, following an IPO for VMware, EMC's remaining 85.6% stake was worth $16B (even more now btw, with total marketcap approaching $27B). And that's after already receiving $218.5M and $150M from INTC and CSCO respectively for a piece of the action.

In other words, for just $625M, EMC (primarily a hardware vendor) managed to buy a software company - a year after MSFT's entry into the segment - and still generate more shareholder value in just three years than MSFT (the world's largest software company) has generated from all of its investments combined over the last decade, with the possible exception of Server and Tools (although that's predates a decade). Oh, and did I mention that along the way VMware has been profitable (something this and other equivalent MSFT efforts almost never are) AND is the category leader despite MSFT's best efforts to unseat them in what even senior management concede is an increasing strategic area?

BTW, for more on VMware see here:

VMware: EMC Has No Plans To Sell More; Did They Price Too Low?

MSFT is a large company and it's reasonable to assume that some opportunities are too small to be pursued because they won't "move the needle" in a meaningful way. However, the current strategy of eschewing base hits for home runs clearly hasn't worked either. The latter have mostly turned into strikeouts, either clearly or soon-to-be. Meanwhile, a few decent base hits like VMware in MSFT supposed core area of expertise (software) -and a strategic one at that - could have put up numbers meaningful even to a company of its size. And in this case it's not like MSFT wasn't there early and spending equivalent amounts of money to succeed. They simply failed to focus, prioritize and win the game. Apparently it was more important to dream about other possible match-ups in different leagues entirely, and spend $20B+ to field new teams like Xbox, for example, only to now risk "becoming a distant third in the battle for market share in the video game business".

The real shame - and waste - is that the internal virtualization team at MSFT probably contains many members who are just as pissed off and embarrassed by this lackluster performance. It's likely not lost on them that just up the road in Washington State, Parallels is generating more buzz vs VMware than MSFT. But they're likely hamstrung by the stifling bureaucracy that's telling us everything will be better if the game goes into extra innings. Server 2008 will come in to relieve, and brings new virtualization/hypervisor functionality. Well, not right away when Server ships mind you - whenever that ends up being. But 180 days later - or thereabouts. Because...well, you know. And "it'll be great" - or maybe just okay. Because...well, you know. That's what Ballmer said about Vista too and look what happened.

Meanwhile the stock continues to under perform. If you're keeping track, that's now under performance versus all three major indexes on an intraday, 5 day, 10 day, 1 month, 3 month, YTD, 1 year, 3 year, 5 year, and decade to date basis. Go figure.

Update: (Related)

Microsoft Plays Catch-Up In Server Virtualization

As an aside, at what point can we hope for a management team that rather than cite their ability to come from behind as a badge of honor, will deal with the underlying reasons why they're always late to market - or at least slow out of the gate - and need three generations minimum before being competitive?

Update #2: (Related)

Does Citrix Have A Chance Against VMware In Virtualization?

Excerpt:

Microsoft is far behind and everybody else, including XenSource, is a speck on the horizon.

Update #3: Some actual good news on the VM front:

How Virtual Machine Manager may help Microsoft compete with VMware

Growth play, value play, or just lousy play?

2007-08-10T13:11:00.001-07:00

That's a question many are asking wrt MSFT. Before trying to answer it let's establish some basic facts, especially since MSFT's current management often work hard to ignore them when they're unflattering (Warning: Long. If you have a more limited attention span and accept a "fact", you can pretty much skip to the next).

1) Fact: Microsoft stock has performed abysmally over the past 5 years

I know, not exactly "news" if you've held this stock for more than a year or two. Still, given current management's refusal to acknowledge it and Ballmer's recent asinine comment that "a lot has gone very well for shareholders over the past five years", I feel compelled to state and support it.

First, during Ballmer's reign as CEO, more shareholder value has been destroyed than was lost by Worldcom, Enron, Tyco and Lucent shareholders combined.

Second, for those who want to cut him some slack given the market meltdown in 2000/2001, let's look at performance since and relative to other industry players. One of my first posts was a recap of a 2004 presentation by John Connors (then CFO of Microsoft). It showed MS's financial results relative to peers during the period 2001-2004. While there was some merit to that compare, it was undercut by the fact that MSFT, the stock, had under performed not one but all of those entities during that same period - a point I made at the time. Flash forward to 2007, and again management is trying to play the "fundamentals" card because the stock has continued to under perform all of these except Sony (note: this and subsequent compares are dividend excluded and use the recent fiscal year-end as the period close). I included a chart in my last post which showed the past five years versus some of them. Since it's difficult to read, here's a breakdown that is complete and adds some additional peers/market indexes (note: data is for the past 5 fiscal years, %'s are approximate - I eyeballed them from the chart - and don't include dividends):

MSFT 8%
DELL 10%
INTC 22%
IBM 43%
SPY 52% (S&P tracking stock)
QQQQ 80% (NASDAQ tracking stock)
NOK 85%
ORCL 98%
CSCO 100%
SAP 119%
SNE -3% (SONY)
CRM 170% (Salesforce.com)
HPQ 175%
YHOO 300%
GOOG 380%
AAPL 1200%

FYI, the ones in blue are the companies Microsoft originally chose to compare themselves to back in 2004, in what was already a self-serving list. If you add the peers that should have been included then and now - INTC, GOOG, AAPL, CRM, YHOO, the S&P, and NASDAQ - the under performance by MS is that much worse.

In other words, the truth is that things have gone very poorly for shareholders over the past 5+ years by the only measure that ultimately matters - stock performance.

2) Fact: Investors have been more than patient

Ballmer explicitly and implicitly stated at the recent FAM that investors have too short a time frame. He mentioned "three years" and suggested that more patience was required. As seen from the discussion above, three years came and went a long time ago. In fact, all "blue" names above except SNE have now outperformed MSFT over the past ten years (fiscal year-end close, dividends out). Ditto CRM, HPQ, YHOO, GOOG, and AAPL. If anything, investors have been too patient.

3) Fact: Management's statements are at odds with observable facts and the stock's performance

Publicly, management maintains that everything is going fantastically. They do this in many cases regardless of observable conflicting data. For example, "A lot has gone very well for shareholders over the past 5 years", while the stock has grossly under performed most peers and all three major indexes. "Vista is experiencing strong momentum", while the CEO of Acer says "the entire industry is disappointed" and MSFT substantially ratchets back previously forecast penetration rates for this year. "Microsoft has revamped its software development process", as yet another product - Office for Mac, this time - slips. Losing another ~$1.9B on Xbox is "actually quite different" from a unsuccessful year, and after investing over $20B since 2001 to generate $6B in cumulative losses with still no end in sight, "We're in a very good position on the fundamentals of that business". The inability to show normal returns from new investments within the "several year" time frames originally guided for, becomes "most of these decisions are not 15 percent IRRs that become 16 or 14. Most of them are winner-takes-all or extremely high net present value decisions if we are successful in the marketplace that we make.". Finally, $100B in buybacks and below-market dividends - over half of which went merely to reduce dilution caused by paying enormous sums to insiders - is "money returned to shareholders".

But let's pretend we're as stupid and gullible as management apparently thinks we are, and ask:

Okay, if the company's current strategies are so good and you're tracking so well against them all, then how come the stock has done so badly, for so long, relative to the market and most peers and despite massive buybacks?

That's one they're seemingly unable or unprepared to answer. Indeed, they want to ignore the stock completely - as they have for most years this decade. Or, as Liddell did at the recent FAM, suddenly agree the stock is important and claim success on the year, meanwhile ignore the fact that it came primarily as a rebound from a major sell off following their world-class screw-up the year previously. When challenged on that obvious lie of omission, they fall back to a two-year compare w/o noting that even that return represented under performance versus all three major indexes.

Management want to fashion this debate as our - and the market's - lack of patience, versus their failure of leadership, strategy and execution. Well, at least publicly. Privately, of course, they lead the entire market in insider selling. They also ensured that their bonuses are no longer based on long-term options (that only had value if the stock rose), but rather on low-risk grants that now get handed out annually versus the previous three years (and vest from there). I guess patience is a one-way street.

John Dvorak sums up this conflict nicely here:

Dvorak: Gates Era Coming to an End at Microsoft

Especially in this passage and the several that follow it:

Meanwhile, the company has to struggle with the reality that it cannot really do much right. This has to drive its people crazy. Okay, maybe not crazy, since boatloads of money are still flowing in, but it must be that because they know they can't do anything right.What I'm saying may be a stretch because it is possible — in some perverse dimension — that some people at Microsoft actually think they are doing things right.

4) Fact: The leadership team's actual track record of investments is decidedly mixed, if not in fact poor.

Again, let's suspend our mounting disbelief and ignore the observable conflicting data points. Overall, management's claim is that they are "investing for the future". The implication being that other companies aren't. Could that be it? Is Microsoft taking a long-term approach while others merely optimize for an often quarterly-focused market? Possible. In fact, it was this long-term approach that attracted me to the stock and kept me in it in the first place. Unfortunately, MSFT's rather anemic results (the slowest growth in their history as a public company two years ago) while others deliver superior revenue and earnings growth year over year (GOOG and AAPL in particular) - and MSFT desperately tries to catch up and emulate them - makes that assertion somewhat strained. It also belies the fact that all the massive investment done earlier, the so-called "emerging bets", were originally justified as being the "next sources of growth". Sadly, while they have helped revenue, collectively they have only detracted from earnings. Which is why as badly as MSFT stock has performed this decade, the best analysts in the business can only justify a 15%-20% upside from the recent - though now a memory - $30 level based on current guidance.

Rather than concentrate on fixing that, in part by better focusing, cutting expenses, and driving the bottom line, management denies any problems and is making new "investments". Again, these are being sold as the future growth areas for MSFT. In reality, they represent the areas that others pursued and proved to be more successful, sooner (to the point where some now potentially threaten MSFT's very future), while management was busy focusing on their still unproven "emerging bets". Leadership shrugs off this criticism even though they're at least guilty of badly blowing expected payoff time frames (remember Bach's "we don't invest in areas to go years w/o making a profit?", when asked about Xbox in 2001?). Instead, they point to Server and Tools as proof of their investing chops: "Go back 10 years and think about the Server and Tools business, which wasn't in existence to any great extent there, which is now one of our fundamentally biggest and most valuable business". Server and Tools is a huge success story. But what about Set-top, IPTV and MSN - all begun around the same time and representing some $15-20B of investment? Or, for a more recent example, how about that stupendous display of fiscal irresponsibility and lack of business judgement known as Xbox?

When "investments" don't make returns and are needed just to defend what you've got, they're called increased operating expenses and shrinking margins. Again, current management want to ignore the adverse impact on overall margins, even comically telling analysts that they should separate the company into core versus new.

5) Fact: Management is arguing with the market and results, and shareholders are paying the freight for that hubris and failure

For the past 5 years or so, Microsoft's leadership has been waging a battle with the market that they're still a growth stock and thus deserve a growth stock multiple (can spend and hire as they please, etc.). For most of that time, MSFT's results have made that statement laughable, which is why the P/E ratio has been deflating (finding support around 20 these past few years) and shareholders have seen their equity destroyed. Now that revenue growth is back to double digits, management is once again beating the drums that they're a growth play. Since the corresponding earnings acceleration isn't there, they keep suggesting that it's "just a matter of time" - well, once they get past the current er... "investment mode". Unfortunately, the market has seen this movie before. They know MSFT has been in investment mode for most of the past decade and yet their business - and most of their profit - is still primarily dependent on PC sales, just like it always was. Only now, due to emerging markets, piracy, competition, uninspired products like Vista, etc, MSFT can rarely even match that overall growth rate.

Many investors would like to see MSFT admit that it's in a mature PC market and that its investments haven't radically altered that. While that doesn't mean they expect the company to give up on new ventures completely, it does mean they want to see the scope of their ambitions decreased and costs come down.

Brier Dudley has a good piece where Goldman analyst Sara Friar (who replaced MSFT perma-bull and perpetually wrong since 2001 Rick Sherlund) lays out that argument:

One of the biggest frustrations I hear out there is why, in what has become a more mature industry, why are we still running the company like it's a start up or a young high-growth company because it's not.

That means in my mind you mature up the capital structure, take on some debt — you lower your cost of capital — you also could do a really substantial stock repurchase.

Personally, while I believe that with the right leadership (strategies, focus, products, investments, execution, etc.), Microsoft could be a lot more successful, grow faster and deliver better revenue and earnings acceleration, it seems clear that the current leadership team has been unable to provide that despite an extensive period in which to demonstrate their ability. At the same time, for those who disagree with me and think MSFT is doomed to being a value play (if anything), it's clear that the management team is totally unprepared to run the company in that manner. In other words, whether you think the company is a "growth" play or a "value" play, it appears we have the wrong management team. Which is why MSFT has largely been shunned by both "growth" and "value" constituencies and the stock has been moribund.

6) Fact: External shareholders are the majority owners of this company

While Gates, Ballmer, and several other insiders (not to mention employees) hold a large amount of shares, the vast majority of MSFT - 80%+ - is held by external shareholders. So it's actually our company and the management team is meant to be working for us. Although listening to them, you get the sense that this is reversed and we're auditioning for the role of bagholder.

Conclusion

Like most investors, you presumably have no interest in being a bagholder, nor did you take a vow of poverty or volunteer to lose money in order to ensure the future of Gates'/Ballmer's legacy. While they might have many reasons for doing the latter (now that they, their kids, their kids kids, etc. are taken care of regardless), I assume you are invested here to make a reasonable return versus competing options. If so, you have three choices: 1) Sell. 2) Continue to be patient and hope the management team eventually delivers the kind of results that will drive the stock. 3) Call for change.

If you've ruled out #1, then the obvious choice imo is #3. It's time for shareholders to understand that the problem is management's failure, not our lack of patience. Ample patience has been furnished already. Patience hasn't worked because leadership, strategies, priorities, execution, and accountability are flawed. The passage of time alone isn't going to fix that. Ask yourself this, is the company stronger now than when Ballmer took over? More respected by customers? More feared by competitors? Do the "trains run on time" better? Have the massively expensive "emerging bets" paid off? Are you more confident in the company's competitiveness and future?

For me, the answer to all of the above is a resounding "No". While there has been progress in some areas, the overall result in each category is a negative, and the stock reflects it. Therefore, Ballmer needs to go. A good deal of the senior management team who have contributed to this failure of strategy and execution, while feathering their own nests, also need to go. The Board, who in apparent contravention of their fiduciary responsibility have sat by while the company's execution has become a punch line and shareholders have been royally screwed over, need to join them. Then maybe, just maybe, this company can get back to basics, execute exceptionally well on that, and rebuild the customer enthusiasm and market confidence in management and their strategy/execution that imo has clearly been lost under the current regime. Until then, as it has for more than five years now, MSFT will remain neither a growth play or a value play - just a lousy play.

Update: Chart update (see previous discussion here):

Like us, or leave us

2007-07-26T15:20:00.000-07:00

That's the effective message Ballmer et al delivered at today's Financial Analyst Meeting. BTW, the market decided to go with the "leave us" option, although it's up a bit in after hours:

Before you say, "But hey, the market was down too". It was. However, most stocks rally on presentations to the financial community. After all, the objective of the exercise is to provide that group with greater insight into management's thinking and strategy, thereby making them more confident, not less. I would also remind you that the exact same thing happened last year. Finally, I would point out the large volume (~88M shares) and significant end of day selling (red):

I was originally going to cover the FAM in detail, but on reflection why bother? Most of it was the same tired, old, self-serving drivel we've heard before. And yet the current management team still thinks that maybe, just maybe, someone will buy it.

The stupidity can be summed up in this statement by Ballmer, which came early in his speech:

If you take a look over the last five years, a lot has gone very well from a shareholder perspective.

He went on to discuss revenue and earnings growth over this particular time period, which of course avoids highlighting the rapid ramp in costs during the past three years (the period, incidentally, that he used when referring to shareholders with [implicitly] too short of an expectation time frame). While Ballmer deserves some kudos for top line growth and - much less so - bottom line earnings during this time frame, the ultimate test for investors is how the stock did. As per usual, Ballmer omitted that little gem. So let's fill in the missing data point:

BTW, that's sans dividends. With dividends (including the one-time $3 fiasco), it would be another 14-15% higher. So call it just a 60% under performance versus the NASDAQ (although the QQQQ's, for example, pay dividends as well). Maybe it did better versus its peers? Let's check:

Er, nope (that's MSFT at the very bottom btw).

It boggles the mind that the CEO of a company whose stock has chronically underperformed the index and its peers by that magnitude, and is currently trailing the NASDAQ by almost 7% YTD (in this its major product release year), can actually stand on stage in front of investors/analysts and claim that "a lot has gone very well from a shareholders perspective". Even more incredulous is that not one of them called "bullshit!".

I'll at least give credit to CFO Liddell for doing what no senior MSFT executive has done in recent history, and that's mention the stock proactively:

Probably of more interest at the end of the day is what that looked like from a shareholder point of view, and that translated into the total shareholder return of 28 percent for the year.

Of course, it was also self-serving and primarily reflects how badly MSFT had crashed the year previously following Ballmer's now infamous spending surprise - a point that Liddell semi-acknowledged:

And, obviously, some of you will say, Well, it was at a low point last year, I could have gone back two years, and it would have been around 25 percent.

BTW, my math for the past two years - again, sans dividends - is more like 19% (~22% with). Unfortunately, having won some points by mentioning the stock, Liddell descends into the same self-serving nonsense as everyone else:

But measure it however you like, last year was the best financial year from a shareholder perspective that we've had this decade, at 28 percent.

Again, it's unbelievable to me that Liddell and others can brag about this with a straight face and no one challenges them on it. Seriously, the translation here is: "Forget the fact that this was in large part a rebound after crashing to three-year lows (following our gross incompetence in managing street expectations), that it came at the cost of another $27B of shareholder cash poured into a tender and buybacks, that it was helped by the hope that Vista was going to be a killer release (now dashed btw), and that it came after badly trailing all major indexes so far this decade (along with the largest destruction of shareholder value in corporate history). Isn't it great?".

That said, Liddell's speech is the only one I found any value in. It's worth a read. He also seemed to foreshadow some improvement in the dividend strategy (which has been a total mess so far). Although he still expressed a preference for buybacks vs dividends. Why, exactly, was left unsaid. Except, of course, that dividends actually go to shareholders, whereas buybacks can be claimed as "returned to shareholders" when in actuality a large part historically has gone to offsetting the dilution caused by paying insiders.

Bottom line, unless shareholders finally push back and call for new management, expect the next five years to look like the last five - best case. While others are spending far less on R&D and reporting massive earnings upside:

MSFT management is calling for no earnings acceleration because they're going to keep spending ridiculous sums on suspect "big bets" and failed business models like Xbox, while continuing to under execute wrt delivering core products that actually thrill users and generate word-of-mouth buying excitement. As regards the stock, expect it to continue to under perform. After all, who wants a mature 8-10% grower that's still spending like it's a high-growth company - and rewarding its upper echelon accordingly - because its management is ineffective and in denial?

Update:

An interesting round up of analyst impressions coming out of the meeting:

Microsoft Becoming an Infrastructure Provider, But More Investment Needed To Drive Services, Analysts Conclude

I guess it must be some of the other institutions represented by the 100-odd professionals who follow the stock that are selling :-)

Q4/07 Earnings

2007-07-19T08:43:00.000-07:00

I'm tied up today and don't expect to post much on earnings this time around. The Xbox charge will blow earnings for both the quarter and the year, so that pretty much negates any anticipation for a "blowout". That said, Ballmer's recent public comments have had a certain unmistakable swagger. So expect the rest of the business to have done quite well. No doubt the company - and analysts with buy recommendations and/or investment banking relationships - will do their best to present the results in that light. Specifically, look for numerous references to "excluding the charge, EPS would have been...". While there's some merit to that wrt understanding how the rest of the business did, the reality is that rightly or wrongly (it's clearly wrongly btw) Xbox is part of MSFT's overall business now. In fact it's a significant part, especially for top line revenue and revenue growth. So excluding that charge is a bit like saying "the date went really well except for the part where I got drunk, spilled a glass of red wine all over her new dress, and she slapped me in the face".

The major focus, of course, will be on anything that gives a sense of how Vista is doing (answer: not nearly as well as it should be, all company rhetoric aside) and of course guidance for the year. Again, listening to the swagger coming out of Ballmer, Witts (who incidentally rivals Liddell for B-O-R-I-N-G) and others at the recent partner meeting, they seem to be very optimistic about FY08 - at least for now. So I don't anticipate any negative change to previous guidance. There's even a chance they could raise it slightly.

WRT the stock, it has suddenly reversed course and been surprising strong after tracking near perfectly against my earlier $28's downside forecast. Not sure what to make of that, except possibly that those comments coming out of the partner meeting caused the street to jump the gun and buy heading into earnings. Hopefully, there are enough positives on the conference call - or at least absence of negatives - that we avoid a post earnings selloff like INTC experienced. Of course, INTC had nicely outperformed the NASDAQ on the year heading into that, whereas MSFT - even given the recent strength, and in this, its major new product year - is still lagging it by more than 6%. So we'll see.

Pre-earnings:

Microsoft Xbox Repairs May Cut Fourth-Quarter Gain (Update1) [I like the "may" part]
Microsoft Q4 earnings preview, Xbox could hit revenue [ditto "could"; It's 7-8 cents after-tax people]
All eyes look to Vista as Microsoft reports
Microsoft earnings today: Xbox 360, Windows Vista

Post-earnings and conference call:

So,

PC growth was stronger than expected (by a full 1%)
Foreign exchange helped revenue (by a full 2%)
"Each business grew revenue at double-digit rates at the high-end of our guidance"
The Windows premium mix did better than expected (up 17% to 72%)
MBD revenue was up 19% versus guidance of 13-14%
Enterprise agreement renewals exceeded the historic range of 66-76%
Dynamics bookings were up 24% (not great vs Salesforce.com, but better than normal)
They sold 400K less Xbox consoles (thereby avoiding the loss per unit * 400K)
243M shares were bought back on the Q for $7B+ (thereby boosting EPS)
Headcount growth came in lighter than usual (again, should have helped income even though it's still excessive at ~10%)

And...

MSFT only managed to meet street expectations on EPS. Huh? Hey, I only report the stuff. I guess Ballmer's swagger was reserved for top line results only - part of a disturbing trend. BTW, notice how the earnings "caption" always gives away the plot? Last Q, for example, when earnings for a beat were there, the caption was "Microsoft Reports Record Profits". This Q, when it's just a meet, the caption is "Microsoft's Annual Revenue Surpasses $50B".

To determine why EPS weren't higher I reviewed the financials. FWIW, the first thing I always do is take MSFT's efforts to make growth of revenue vs earnings less easy to compare, and rearrange it so that it's clear cut. That yields a table that looks like this:

At first glance - and ignoring the usual losers - the issue would appear to be Client (see red highlight). That failure of earnings growth to match revenue growth is a real concern. But it's been one for a while, and includes such macro items as an increasing percentage of sales coming from emerging markets (where Windows sells for less). Indeed, Client revenue growth (at least) was actually within forecast (14% vs guidance of 14-15%). It's actually Server & Tools that came in light on revenue versus guidance (15% vs the 16-17% forecast). Additionally, they only matched on earnings growth (versus exceeding it as they have on some previous occasions). According to Liddell, some of the top line issue may have been a result of stronger than expected EA renewals. Whether that played any part in the bottom line impact is unclear. Finally, you have MBD coming in way above plan on revenue (19% vs guidance of 13-14%), but only matching that growth on earnings (it too has done better than that in some previous quarters). Bottom line, who knows? It's a $100M-$300M earnings mystery wrapped in an enigma - or maybe I'm just too tired to analyze it further. On the all-important Vista issue, it's clear from comments that adoption is behind expectation. Liddell's actual euphemism was something along the lines of "we're broadly happy with Vista adoption". But in the Q&A, he was forced to concede that MSFT took down expectations for next year from 85% Vista/15% XP to just 78% Vista. What did Ballmer say again? Oh right, "Vista will be great - bet on it". He must have meant "eventually". Rounding things out we have the pre-announced Xbox loss, which came in at $.08 (the high end of the previously given range of course). That took total losses in E&D for just the past two years to a whopping $3.176B. Yup, that's a "strong business" alright. Finally, Online continues to be a financial sinkhole and will lose money again next year (Xbox business plan redux?). Forecast revenue growth of 10-13% for Online in FY08 is also a joke compared to GOOG, YHOO, or the market as a whole.

So overall, revenue came in roughly as I expected. However, bottom line results were weaker (I expected 1-2 cents upside). Guidance for next year is in line with what I anticipated (i.e. a slight increase), which ultimately is good. But the implicit confirmation about Vista sluggishness, combined with the lack of margin and earnings acceleration next year - and guidance to continue hemorrhaging in Online, will likely take the wind out of the sails of the extra bullishness that had been building following management's recent upbeat comments. Some analysts may still take their estimates up slightly following the call (assuming that MSFT was just being conservative as usual). But I doubt we'll see anything like what followed IBM's strong results. BTW, IBM stock has now handily outperformed MSFT over 1, 3, 5 and 10 years. So much for MSFT being the "new IBM" - we should be so lucky.

For its part, MSFT is down in AH trading. Although exactly how much is subject to some debate (NASDAQ reporting last trade @ $30.90, down .61 from the close; MSNmoney and YHOO say $30.83, down .68). It will likely open weak tomorrow as a result (despite the MM's best efforts). It could have been worse though. Just look at GOOG in AH - down $39.06 according to MSNmoney (and it was down forty-something at one point). That should also hurt the market tomorrow.

Update:

For Microsoft, Meeting Expectations Apparently Not Enough

"For people who think Microsoft is still a growth story, it's disappointing. It's a mature company in a mature industry with declining prices," Chowdhry added. "For people who think Microsoft is a value company, what they delivered today was quite good."

What did they know, and when did they know it?

2007-07-09T08:34:00.000-07:00

The focus of my initial post on the latest Xbox fiasco was primarily on the seemingly endless trail of management incompetence. In thinking about the issue further, I'm not sure that's enough. In fact, I'm wondering if this situation isn't potentially far more serious, possibly even actionable. I'm also wondering if my initial inclination to discount calls from commenters for an SEC investigation was right, and whether that may not be a possibility after all - or at least a risk.

It's one thing to stonewall and put a positive spin on bad news. We might disagree on the extent to which that should be condoned, but it's not illegal per se and is unfortunately commonplace. It's another thing entirely, however, for the executive officers of a public corporation to knowingly make false statements to media and analysts, attempt to conceal material information from shareholders and possibly even from reported financials, or remain silent while seeing others engage in that behavior. At best, it is unethical/unacceptable and risks a shareholder lawsuit. At worst, it raises the specter of a full SEC investigation and resulting charges/fines/restatements if found guilty - not to mention shareholder lawsuits.

Determining which we're dealing with here, seemingly hinges on answers to a relatively short list of questions, none which MSFT has addressed publicly, but all of which the Board could easily determine (more on that later). They include:

What is the overall Xbox 360 failure rate due to manufacturing defects/design shortcomings?
When did it first become "unacceptably high"?
What was the "acceptable" threshold and how does it relate to industry norms?
If it is significantly higher, what is the justification for the delta and who authorized it?
To whom was the abnormal failure rate information communicated and when?
What actions were taken to address the problem, by whom, and when?
Were any of the subsequent remedial changes recommended during the initial design and/or manufacturing process? If so, which ones, why were they ignored initially, and who authorized it?
Was proper accelerated life testing done before launch? If not, why not? (FWIW, Bach says it is being done now).

Here's a very cursory and incomplete review of event chronology:

November 2005: Xbox 360 is launched

Shortage of available units is blamed on insufficient manufacturing ramp up time. Others later charge that this was a result of - or at least exacerbated by - low yield, which itself should have acted as a warning of future problems.

Articles detailing how to fix the overheating problems begin to appear almost immediately.

MSFT's own Mini-Microsoft does a post on the topic of overheating and red circles (later called Red Ring(s) of Death or RRoD), which turns out to be rather prophetic.

MSFT responds with:

The vast majority of Xbox 360 owners are having an outstanding experience with their new systems.

December 2005

Robert Byers, a Chicago man who purchased the Xbox 360, files suit in a federal court accusing Microsoft of selling a defectively designed product.

September 2006

September 22, 2006, MSFT admits to problems with some early units, waives the cost for repairs on all Xbox 360 consoles made before January 1, 2006, and refunds any fees already paid.
By this point, MSFT has a full page dedicated to the issue on its web site, and RRoD is one of the command prompts on the support line.

June 15, 2007

Todd Holmdahl, Microsoft’s corporate vice president of Gaming and Xbox Products Group, does his best to deny there is any abnormal failure rate, claiming the issue is limited to a "vocal minority".

July 5, 2007

MSFT admits the problem, calls the number of failing units "unacceptable", changes the warranty for RRoD specifically, and takes the $1B+ financial charge.

Peter Moore, Corporate Vice President, Interactive Entertainment Business, Entertainment and Devices Division, indicates that they began investigating this just "weeks ago".

Robbie Bach, President, Entertainment and Devices Division, states that:

For a little over the first year this problem, or this set of issues, wasn't visible at all.

MSFT adds that:

The majority of Xbox 360 owners are having a great experience with their console...

[Hmm...that last one sounds familiar somehow. Only "vast" got dropped from majority, and "outstanding" is ratcheted down to just "great". Is MSFT legal doing some advance damage control?]

Given the scope of the problem, resulting financial charge, and potential risk of future legal and/or SEC exposure, common sense - not to mention fiduciary responsibility - argues that the Board of Directors get involved to satisfy themselves that appropriate, defensible answers are forthcoming to the questions above. And not wrt word-games about the meaning of "minority", or wasn't visible for "this set of issues". But on the core topic of overall reliability vis a vis industry norms, and MSFT's resulting actions. Specifically, Moore is quoted stating that:

The information that we knew we had a bad box, we kept shipping it. That’s completely wrong.

The Board needs to determine if that is accurate, using generally accepted industry standards for failure rates as the hurdle. If it is, great. Although by way of full disclosure, I should add that I'm beginning to seriously doubt that is the case. Even if it is, there seems to be no interpretation under which Holmdahl isn't guilty of being hopelessly deceitful when he made his statements defending Xbox reliability three week ago. As such, he needs to be severely reprimanded or fired.

If, on the other hand, those acceptable answers aren't forthcoming, then it's very serious. Under that scenario, imo, every senior manager who knowingly tried to conceal the problem, made false and misleading statements, and/or stood by while they were aware of others doing so, should be fired - period. If that includes Ballmer, he should step down. If charges should have been taken earlier, or shouldn't now be taken as special one-time ones, then bite the bullet and restate/change future guidance accordingly.

Shareholders deserve a clear assurance that management acted appropriately in this matter and can be trusted. The current leadership word-games, unwillingness to detail the specific nature of the issues, and refusal to confirm whether overall failure rates are at or below industry norms, is not providing that. Will the Board act to fill the gap?

Update: Related.

Confession is Good For the Soul: Why Microsoft Must Be More Forthcoming About the Xbox 360's Flaws--Or Initiate a Recall
Microsoft sued over Xbox 360 (this time for the other widely-reported problem: disk scratching)
Bach Sold Stock as Xbox Problems Mounted
Microsoft casually dismisses hardware complaints
Xbox 360 Recalled by EB Games Australia
Microsoft exec under fire for selling stock

Update #2:

Moore leaves MSFT

What's another $1B among friends?

2007-07-05T16:41:00.000-07:00

The train wreck that is the current leadership team of Microsoft, continued their winning ways today. For months they have been stonewalling and denying that Xbox 360 had reliability problems despite widespread reports indicating otherwise. The latter had reached a crecendo recently, but have plagued the unit since its introduction. Today, they admitted the obvious: there is a problem and they are going to fix it. In other words, they finally did what most ethical, customer-focused, and intelligent management teams would have done from the start - told the truth and committed to making it right. But this is Microsoft, so honesty and fixing mistakes often takes longer and only occurs after massive external pressure is applied.

As someone who posted about how ridiculous it was for MSFT to continue ignoring this issue, I'm glad to see them finally step up. However, even I am amazed at the extent of the problem and the resulting price tag: $1.05B-$1.15B. No, that's not a typo. That's what MSFT says it's going to take to fix it. Oh well, what's another $1B+ when you've already invested some $24B to generate $5B+ in cumulative losses so far? Meanwhile, having crashed and burned in Xbox, blowing upcoming quarterly earnings and EPS for the year company-wide in the process, management decided they might as well air all the dirty laundry. So CFO Liddell slipped in that oops, they also missed their already downwardly revised guidance for Xbox 360 unit shipments - well, after an analyst noted the differential and asked him point blank about whether that was confirmation of a miss. Excellent. Combining the above, scratch one of the last remaining areas where MSFT's current leadership was still considered competent: conservative forecasting.

Returning to Xbox 360 failure rates, what are they exactly? MSFT still isn't saying. Here was the answer from Todd Holmdahl, Microsoft’s corporate vice president of Gaming and Xbox Products Group, three week ago:

I would go back and say the vast majority of people love their experience. We continue to go back and address all of these issues on a case by case basis. There is a vocal minority out there. We go off and try to address their issues as quickly and as pain free as possible.

Here it is today from Robbie Bach, president of Microsoft's entertainment and devices unit:

"It's a meaningful number and it's got our attention,'' Bach said. "When you look at the financial implication, obviously it's not a small number."

Todd and Robbie work in the same division and talk to each other, right? FYI, the MSFT press release calls the number "unacceptable". Directions on Microsoft analyst Matt Rosoff is quoted stating that the charge is sufficient to fix 2.5M units. Doing quick math, 2.5M on 11.6M total shipped would suggest a failure rate in excess of 21.5%. But there are numerous unkowns which could skew it higher or lower. Bottom line, it's far above the 3-5% rates considered "normal" for the industry. It's also MSFT's fault apparently (read inadequate design, not poor manufacturing):

Flextronics International Ltd. manufactures the Xbox 360. Bach said Microsoft takes responsibility for the problems and won't be seeking to replace Flextronics.

So what does Bach have to say overall? He'd like you to know that:

the issue was the result of a "complex set of factors'' and it would have been difficult to predict the problem in advance. The failures cropped up in the past few months and weren't apparent in the first year the machine was on sale, he said.

In other words, don't blame him even though he's in charge and gets paid $10M's per year - shit happens. Oh, and that teeny weeny fact that they've known about this for at least "the past few months" (if not 8-18) but were vehemently denying it as recently as three weeks ago? Well, er... did I mention that shit happens? But wait, he's not finished making a fool of himself:

"Our goal has been to have Xbox profitable in the coming fiscal year 2008," said Robbie Bach, president of Microsoft's entertainment and devices unit. "We don't think this changes that in any way."

Doesn't change that in any way? Is Bach retarded? First, they missed their already revised unit forecast for the year and took a massive unexpected charge. As a result, they blew what remaining credibility they had left - which after years of failures, losses, and missed profitability targets, admittedly wasn't much. On top of that, the runaway success of the Wii (and resulting need for MSFT to do something more aggressive on price) was already calling the validity of this '08 forecast into question. Second, the media and competitive fallout from this, including the fact that they may have sat on 20%+ failure rates w/o doing anything about it (except try to aggressively deny it), is going to be huge. It will undoubtedly have a negative impact on unit sales vs previous forecasts. Third, announcing on July 5th that you're retroactively taking a $1B+ charge for last fiscal, and then acting like this fiscal's results are unaffected, is simply comical - and disingenuous. Fourth, even if the division does show a profit on the year, what difference does it make now that Xbox (as an overall investment) goes from $5B+ in the hole to $6B+?

How many more similar fiascoes, obvious management lies, sales misses, financial hits, company credibility blows, and massive failed "investments" is it going to take before MSFT's Board of Directors steps in and demands real accountability and change on behalf of shareholders whose interests they are legally chartered with protecting?

Update: Related:

Failure Rate: Xbox 360 High As 33% - Sony PS3 & Nintendo Wii Less Than 1%
Mr. Softy's Extended Embarrassment
MSFT Conference Call
Open Letter From Peter Moore
Microsoft’s Peter Moore sends memo to his troops on Xbox 360 “warranty enhancements”
Peter Moore and Microsoft's Red Ring Woes
Save Us, Nintendo (Motley Fool writing in Sept 2006)
"It's a common flaw. Microsoft even has an entire page devoted to it, and it's also one of the prompts on its customer service line."

What will Microsoft learn from the iPhone?

2007-06-30T12:49:00.001-07:00

Before you groan, I too want to hear more on the iPhone about as much as something new regarding Paris Hilton. The media-saturation has been insane. On the other hand, I am interested in what lessons MSFT will take away from this current phenom. Will there by any?

Microsoft has been in the mobile business for over a decade. They've been in the specific phone sub-segment since 2002. In fact, Windows Mobile is now on its 6th generation. MSFT also spends an order of magnitude more on R&D than AAPL. So how come MSFT has never once had a phone product, during that entire time frame, that has come even distantly close to matching the consumer and media interest generated by the iPhone - which only just shipped? Indeed, across all of MSFT, the only product that has come close is Windows 95. Let me add a couple of caveats before proceeding further: First, I don't know if the actual iPhone will live up to the likely overdone promise of the iPhone. Second (and related), I don't know how well it will do in the market, though I think they will easily make their unit guidance for the year. Regardless, the iPhone has already had a massive impact. From media, to consumers, and the market (where AAPL stock has recently tacked on another $30B of marketcap based largely on iPhone anticipation and interest), everyone is talking iPhone.

I have my own thoughts on why/how AAPL managed this engineering and marketing triumph. The more important question is does MSFT? Have they even bothered to put together a senior cross-discipline team to study the situation, including how AAPL managed to come out of left field and accomplish it? This isn't just about a new phone. The iPhone highlights issues in R&D, customer needs understanding, UI design, software development, go-to-market strategies (e.g. partner or direct), marketing, etc. These are areas that aren't peripheral for MSFT, they're core - or should be. And MSFT should be the undisputed world leader. They aren't.

MSFT needs to look across the company and answer the question "why can't we do this?". What is so broken that Windows 95 is the most recent example of similar [MSFT] success? Why did Vista, a product that took 3-5X longer to develop than the iPhone, greater than five times as much R&D, and touches several orders of magnitude more people, fall largely flat? MSFT is even having to simplify the downgrade rights from Vista to XP. That's hardly a bullish indicator for adoption. And here is Ed Bott -one of the most knowledgeable Windows writer out there - defending (?) Vista by saying it's like Win95 not WinME (as others are charging), while acknowledging that it will likely require the Win98 equivalent before fulfilling the original promise. Wow, what a ringing endorsement. And it's not just Vista; Similar could be said for Zune, Windows Mobile 6.0, Internet Explorer 7.0, etc., etc., etc..

My guess is that current leadership hasn't bothered with that review. I bet they have already rationalized (to their own satisfaction) why their approach is still the best one, and why the iPhone phenom is of only marginal importance. As a result, nothing will change. MSFT will continue to ship often mediocre products (at least on revs 1 and 2) to lukewarm reviews. They'll keep ramping up marketing launch budgets in the asinine hope that these same products will do well if only they get pushed hard enough. When that fails, as it consistently does, they'll spend their time crafting ridiculously misleading "momentum" press releases in the vain hope that it will turn the tide. Finally, they will cycle through the litany of handy excuses that have become their trademark this decade, including "market saturation", "not every product is a growth opportunity", the "notorious risk-adversity of enterprises", or the multi-purpose catch all: "it's still early innings". MSFT, under current leadership, should be renamed Excusesoft.

I'm not alone in doing the comparison and asking these questions. If you've been following the stock's major YTD underperformance (NAS up ~8%, MSFT down ~2%), and current meltdown, there's good evidence to suggest that many investors are:

FYI, the green line that I've added to the bottom chart highlights money flowing out, along with the impact on the stock in the top chart. FWIW, that long-term uptrend line that I've drawn (purple) had better hold, otherwise it's BOHICA for shareholders. That's somewhere around $28.69 or so, if you're interested. But look for a range between $28.40-$28.80. If it fails, technical analysis suggests that MSFT could eventually crash back to around $22.40. In other words, the Ballmer-led MSFT elevator is headed either to the Mezzanine level, or all the way to the parkade basement again. Getting tired of this yet? If so, when the proxy rolls around this year, send a message once and for all.

Update: An upgrade by Pacific Crest is worth a read and helped generate some buying interest during a pre-holiday shortened session. That lifted the stock back above $30, eventually hitting a high of $30.22 and closing the previously open upper gap in the daily chart (see red lines below). The stock then immediately reversed course (green circle). For now, it managed to hold $30 (with two cents to spare). However, there are several lower gaps still open (red circles) and unfilled gaps that stay unfilled are exceedingly rare for MSFT.

Update #2: July 6th, 2007. Latest Xbox disaster has provided the catalyst to close the first lower gap. Next up, lower gap number two (~$29.47) ...

Update #3: July 10th, 2007. Stock takes out lower gap number two as expected. Next up, $28's.

Update #4: August 10th, 2007. It took longer than expected, but today we are trading in the $28.40-$28.80 range that I called for in the post. In fact, we took out the low end by trading down to $28.31. The stock is currently at $28.54. As I said then, a failure to hold here risks another trip to the basement. The fact that we so easily undercut that range doesn't bode well.

Who us - leadership? Nah, we just vest here.

2007-06-20T15:57:00.001-07:00

Regular readers know that I'm a staunch critic of Microsoft's current leadership team. In fact, I'd argue they don't even deserve to be called that and instead resemble the Keystone Cops. Now, you might assume that this is primarily because of the stock's non-performance - and I'll admit that's a big factor. But it's also the endless strategy/execution issues and constant inability to get even minor details right. IMO, that shows a company that is badly led and poorly managed.

Here are just a few current examples:

Windows Ultimate Extras is a sham - where’s the responsibility?

It's always wise to take your premium-priced offering, justified in part on the promise of future "extras", and then stop delivering those amid rumors the team responsible has actually been disbanded. Meanwhile, MSFT cans the Digital Image Suite which arguably would have made a great extra (though MSFT says most of the functionality is in Vista already - it isn't).

Microsoft’s Dead Naming Strategy

Couldn't agree more. Is there anyone driving MSFT's overall branding and marketing? It sure doesn't seem like it. Add to the list of confusion three different products that all contain the name Messenger. WTF? This is really too bad because many of the "Live" products are superior to competitive offerings - but most users aren't going to wade through the confused naming/marketing message to try them. Oh well, at least "Microsoft TV: IPTV Edition" got renamed Mediaroom. Not exactly creative, but at least it's an improvement.

"Mum's the word" as Microsoft quietly updates 360 hardware

Did we upgrade the heatsinks in light of widely reported overheating problems? Well, we're not going to say specifically, even though pictures documenting the change exist, because er, ...why be honest?

A Q&A with Todd Holmdahl, the hardware guy at Microsoft, about Xbox 360 failures

Related. Can anyone read Holmdahl's responses and NOT conclude that Xbox failure rates exceed the industry average? So let me see if I understand the strategy here. Having lost $5B+ on the Xbox fiasco so far, with the ONLY hope for payback - no matter how unlikely - being via subsequent games sales and related, leadership thinks being less than forthright about overheating and reliability problems (not to mention blaming users for scratched disks despite evidence that it's a hardware problem) is going to get buyers to invest more in the platform? Brilliant.

How Google Stole My Desktop (From Microsoft)

This person obviously didn't get the memo from Raikes explaining that there's no demand for this type of solution and why it's therefore not in MSFT's future.

Microsoft bails on virtualization licensing changes for Vista

Oh, did we just brief the press on changes we were making? Sorry, consider it a belated April Fool's Day joke.

Microsoft Concedes to Google and States, Will Change Vista Search

Ballmer: the allegations are "baseless". Days later, MSFT agrees to make changes. Apparently several state AGs, already pissed off at MSFT for past infractions, thought it had enough basis to threaten legal action if MSFT didn't comply. [BTW, this helped tank the stock as the revelations included timing of Vista SP1 which now looks like next year (beta late this year), thereby potentially pushing out Vista migrations even further.]

Google Has Most Online Searches in May

Excerpt: "Yahoo's search total grew 18.6 percent from the year-ago period, according to Nielsen/NetRatings. Microsoft Corp.'s MSN/ Windows Live took third place with 605.4 million searches, or 8.4 percent of searches in May. The service experienced 0.8 percent search growth year over year."

Remind me again, didn't YHOO's CEO just get ousted for his performance? 18.6 vs .8? Will there be ANY equivalent accountability doled out at MSFT? That's rhetorical btw as the answer is an emphatic "No".

Okay, so it's likely over-hyped. But can someone remember the last time a MSFT product caused anyone to drool or caused a traffic jam? MSFT is spending an order of magnitude more on R&D than AAPL and taking at least twice as long to get products to market, right?

Unsurprisingly, after a brief run, the stock returns to regular programming. For example, versus the NASDAQ (dividends excluded), MSFT has now underperformed over:

1 day
5 days
10 days
1 mth
3 mths (just)
YTD
3 years
5 years

(Over one year, it's still ahead).

Meanwhile, where's MSFT's Board of Directors? MIA, as usual. Bottom line, if shareholders expect change then we're going to have to demand it.

Some days you really have to wonder...

2007-06-15T16:24:00.001-07:00

Why any of us continue to hold this stock. For example, here's the list of equities I track on a daily basis:

Notice anything unusual there? That's right, of every stock I track, only MSFT was down today. Off .1% while the NAS is up a full 1.05% - and that's despite already under performing the NAS by ~6%+ year to date. WTF?

Reviewing the news, nothing particularly stands out as a likely cause for today's under performance. Nevertheless, the price action speaks for itself and volume is significantly above-average - so you can't write it off as meaningless. Now, in fairness, it was a triple witching day and that often causes some aberrant behavior. While that might explain the higher volume, why was MSFT the only issue from that fairly long list who was unable to close in positive territory? Sure, any stock can have a bad day, but we see this kind of action in MSFT repeatedly.

In the absence of material earnings acceleration and/or other investor-generating interest, there just doesn't appear to be any sustained incremental demand for MSFT whatsoever. Even a rare "bullish" PC analyst that I saw recently, recommended just about everyone but MSFT to play the trend - his specific worry being the long-term adverse impact from GOOG. Recall that with Vista, the new Office, etc. this was meant to finally be MSFT's big year. So far, for investors, it's been a bust. MSFT continues to be a piñata that exists purely to entertain large funds and institutions, who proceed to whack it up and down all day, every day - disgorging 10's or even 100's of millions of dollars for themselves in the process off fractional per share moves, while the overall direction remains flat and long-term holders continue to make nothing.

Current management appears to be mostly resigned to this state of affairs, even helpfully refilling the piñata every once in a while with some fresh shareholder buyback money and taping up the seams when it looks like maybe it's going down for the count. Then the Wall St. game starts all over again. As long as leadership continues to receive massive share and option grants for free, institutions continue to redeem those shares for cash in exchange for unfettered access to the daily piñata spoils, and shareholders continue to underwrite the cost via continued under performance without calling for heads to roll either at MSFT or at those institutions holding it, then life is good. MSFT's leadership can continue to run the company - as they have for this entire decade so far - as their private fiefdom and for their personal enrichment versus as a public company charged with rewarding its shareholder owners. And given the totally lackluster reception of Vista so far - at least in the consumer market - despite repeated Ballmer promises that it "would be great - bet on it", combined with continued reckless spending, it doesn't seem likely that we'll see earnings improvements that might drive [new] investor interest any time soon. Additionally, we're heading into MSFT's fiscal year end when, among other things, grants and options get set - and you know MSFT loves to game those to be as low as possible. So don't expect any major announcements from them aimed at driving the stock - like say a market dividend, or better yet Ballmer's retirement. Also expect buybacks to get curtailed significantly unless earnings are coming in weak and need to be juiced again by reducing shares outstanding.

Looking at the long-term chart, about the only potentially bullish takeaway is that you could make a technical analysis case for a run to $40 if this seemingly endless consolidation trend ever gets resolved to the upside. Whether it will before MSFT sees the major financial challenges that are almost surely on the horizon given the current strategy, leadership, and execution shortfalls, is any one's guess. Until then, MSFT likely remains what it's been since Ballmer took the helm as CEO in 2000: worse than dead money.

Time for a change. After nearly a decade, this is getting old...

Where is the MSFT/Ballmer outrage?

2007-06-13T15:54:00.001-07:00

Like a lot of folks, I've been watching the evolving shareholder unrest at YHOO. In case you missed it, shareholders there are unhappy with the company and its CEO Terry Semel. In fact, they've been making that increasingly clear of late, including at a shareholder meeting today. See sample coverage below:

So what are the specific complaints? Well, the list includes poor stock performance, unclear company direction, poor CEO leadership, lavish executive compensation, etc. Hmm...sound familiar?

Reviewing the record of stock performance, certainly YHOO has not had a good time of things over the past year:

Or even over the past 3 years:

However, Semel took over as CEO in May of 2001. So let's see how he's done since then:

I don't know about you, but a greater than 160% gain for YHOO vs an almost 20% loss for MSFT looks pretty decent to me.

In the area of company direction, it is legitimate to question how badly YHOO has done versus GOOG. While YHOO still holds a position that MSFT can only dream of (despite spending more than twice as much on a relative basis in order to achieve), they've clearly failed to check the progress and otherwise keep up with GOOG - and they were in that business already. But of course, MSFT's failures in this and other businesses during the same time are legend. In fact, read this latest piece on the continuing screw-up known as Xbox, which includes this astounding admission from Peter Moore, head of Microsoft's interactive entertainment business division:

If we don't make that move, make it early and expand our demographic, we will wind up in the same place as with Xbox 1, a solid business with 25 million people. What I need is a solid business with 90 million people.

Unfreakinbelievable.

Now, in the area of compensation, Semel got paid a ton - $107.5M is one estimate for last year. Ballmer, by contrast, gets paid a rather nominal amount. But again, looking at the company overall (including the Xbox dream-team above), MSFT's executive compensation doesn't take a back seat to many people - YHOO included.

So what gives? Why are YHOO shareholders rebelling vocally and calling for a new CEO, while MSFT shareholders, who have experienced far worse returns over the tenure of the current CEO, continue to just meekly grin and bear it? Is it that MSFT shareholders somehow feel the worst is over and the company is now on the right track, whereas YHOO shareholders don't? Or have YHOO shareholders just not completely given up and settled for abysmal stock performance and sloppy leadership/execution yet?

Update: Blodget on the YHOO situation:

Shot Heard Round the Yahoo

Update #2: Latest console sales stats:

Nintendo Shames Rivals Again

Update #3: Semel is out as CEO:

Yahoo Replaces CEO Terry Semel

YHOO, which was already up 3% on the regular session today, is up another 4.3% in AH on this announcement.

It's Official: Ballmer has lost it

2007-05-21T14:37:00.000-07:00

I should probably add "completely" since there were signs of increasingly erratic behavior along the way. Starting early, for example, we saw extreme denial as he argued that the company would prevail against the DOJ and be found innocent. That was quickly followed by manic confidence in "emerging bets" which, 5+ years later (actually decades in some cases), are looking more like a disastrous binge in Vegas after failing to take his lithium versus anything remotely approaching a business investment. Then there were the delusional "bet on it" promises that Vista would be "great" and that MSFT would quickly catch and surpass GOOG [Apple, CRM, insert xyz other company kicking MSFT's butt then and still currently]. Thrown into the mix, were the occasional Tourette-like stock-tanking remarks - as in "Surprise! We're going to spend $2-3B more than we let on previously". However, as bad as that is - and it's pretty pathetic - it pales by comparison to news Friday that MSFT is set to acquire aQuantive for the astronomical price of $6B. In Search/Advertising, it would appear, Ballmer has finally wigged out. Either that or he's found a business in which he can lose more money, faster, than even the asinine amounts he's already lost on Xbox, MSN, IPTV, etc. - which is really the same thing.

Recall that just a few weeks ago, it was DoubleClick that was the target of his addled affection. But we know - or at least think we do - what happened there; MSFT offered to outbid GOOG's $3.1B cash deal but DoubleClick backers opted for GOOG anyway. Then 24/7 Real Media became the target of his infatuation, but that went to WPP group for $649M cash (notice how everyone avoids stock these days?). Now suddenly aQuantive is the perfect fit, and all that fiscal responsibility that MSFT has been bragging about with each successive bidding loss these past few months is a thing of the past. Here's how Liddell describes this $6B purchase - the largest acquisition in MSFT history:

We're happy with the price we paid. We believe it's exactly the right company to buy so we're willing to pay the value we are paying today," said Chief Financial Officer Chris Liddell. "We will use the strength of our balance sheet when we think it's necessary to drive growth going forward.

Is aQuantive everyone else's leftover and a poor choice? No, it's an excellent company. Here's an overview of why (nice and timely call btw Briefing.com). However, it was also a great company last year, the year before that, the year before that, and the year before that - when incidentally it was trading at a fraction of the current market price and already on the radar of investment forums including MSFT's own Moneycentral (not to mention being right under MS's nose in Seattle). But just like in '00/'01, when Ballmer could and should have been using MSFT's [then] legendary cash pile to make a ton of smart accretive acquisitions for pennies on the dollar, he was too distracted. This time, instead of the DOJ, it was OSS, the Vista screwup, and fantasy delusions that GOOG could be caught any time soon and via an in-house only strategy. Well guess what? The latter has been a failure, as subsequent market share data makes crystal clear. And this expensive and rather desperate acquisition is proof positive that even Ballmer acknowledges it. So, once again, shareholders get to pick up the tab. And not just an already inflated tab (from around $8 several years ago, to <$30 before the DoubleClick deal, to ~$36 before the news Friday) , but a whopping 85% premium to that. As Warren Buffett says, "The best side to be on in a bidding war is the losing side". So why did MSFT management do the unthinkable and not only engage in, but win, a bidding war? Because they once again failed to proactively understand the market and competitive forces and thereby position the company advantageously and cost-effectively. But rather than refocus/regroup after this latest strategic blunder and consider why their largely me-too strategy has been a failure to date, they're just going to "double down" - using our money. And that's going to somehow "change the game". Such is the collective brilliance that we paid $1B in bonuses for.

As you can tell by now, my concern isn't just did MSFT overpay. While you can argue that it equates to less per sales dollar than say, Google paid for DoubleClick - and some supporters of the deal have - I personally have no doubt that MSFT overpaid by any reasonable accounting analysis:

aQuantive generates admirable free cash flow, but everything has a proper price, and Microsoft sure doesn't seem to be paying it here. Discounting likely cash flows, and assuming a huge growth rate of 30% a year for the next half-decade(before some minor cooling), I'd value aQuantive at $45 a share on the very high end. By my math, Microsoft is paying 54% too much, even if things turn out great.

In other words, based on the math alone, this deal might pay for itself sometime in the 2020's - right around the same time that Xbox gets to lifetime breakeven (maybe). Therefore, the critical issue for shareholders imo is having overpaid, can MSFT possibly make it work and how? Beyond the obvious financial obstacles discussed above, there are real business, integration, and strategic, concerns. For example, just this past week, the CEO of AQNT was citing their "independent" position as a core competitive advantage:

We think we can continue to win market share from DoubleClick as we have consistently over the past five years, and now we have the added opportunity of being the only independent player

Hmm, when you throw $6B around it seems that former deeply-held convictions can go out the window. However, for all except the brain-dead, it clearly was and is a major business consideration with unclear implications now that AQNT will no longer be "independent". So how is that going to be resolved and what impact will it have on AQNT's current and expected sales? More importantly, how is this addition going to possibly re-position MSFT's overall money-losing, distant #3 Search and Advertising business in such way that it can recoup that $6B and actually turn a profit on it? Oh, I forgot, current management never concerns themselves with that last part. There's a lot of talk about benefits outside of Search and Advertising for MS. To make it work financially, there almost have to be. But what are they? Is there a play here for Office? Servers? Tools? Will MSFT save some money by say, drop-kicking their current ridiculously bad advertising partners who have brought us the lackluster/non-existent Vista and Zune campaigns, replacing them with AQNT's talent instead? And does it seem odd that a company who's advertising generally sucks (MSFT), especially versus competitors like AAPL, thinks they can "win" in this particular space? Maybe Ballmer can help us out here. Let's look to him for some clarification on the strategy and business justification underpinning MSFT's largest-ever purchase:

The advertising industry is evolving and growing at an incredible pace, moving increasingly toward online and IP-served platforms, which dramatically increases the importance of software for this industry,” he said of today’s deal, adding that it, “represents the next step in the evolution of our ad network from our initial investment in MSN, to the broader Microsoft network including Xbox Live, Windows Live and Office Live, and now to the full capacity of the Internet. Microsoft is intensely committed to creating a thriving advertising business and to partnering closely with all key constituencies in this industry to help maximize the digital advertising opportunity for all.

Have you ever heard more meaningless, content-free, doublespeak in your entire life? This is the "next step" in MSFT's overall unprofitable Online and H&E strategies? Wasn't the next step supposed to be making money - finally? How is an extra $6B of costs going to do that exactly? I mean, is all this just about demonstrating "commitment" to this space? With that kind of reckless financial stupidity it's Ballmer who should be committed - to an asylum. And how will the net result be different from the abject failure to date if we're stuck with the same me-too strategy? As one report noted while discussing why MSFT has lost its innovative edge:

In the old world of technology, Google's ad push might have been met with the announcement of a killer technology, possible for something unrelated, or even more likely for some new online ad-serving technology that lets Microsoft push commercial content simultaneously to online, TV, podcast, radio and for output in various print and display venues. That didn't happen.

I agree. What is the plan? If it's the one evident currently - namely to beat GOOG by copying them only slower - then Ballmer is out of his mind. There is NO hope that is going to happen in the short term. Instead of focusing on a competitor, MSFT should concentrate on a customer niche that it can dominate and then build from there. For example, I have long argued that MSFT should try (directly and in partnership) to position itself as the most-effective vehicle for advertisers. In other words, not necessarily the biggest (duh), but the one who has the deepest market knowledge - at least within some core verticals - and the one who can provide the best effectiveness and tracking for advertisers. Even if the latter means - gasp - placing advertising across competing networks. Right now, online advertising is a free-for-all. But over time advertisers will gravitate - and pay a premium - for those entities who can demonstrate the most bang for their buck. AQNT's deep expertise could help in that, but you need a focused strategy first. Otherwise, whatever they bring to the table will be quickly diffused across too many conflicting efforts - like ignorantly trying a frontal assault against a dominant entrenched competitor like GOOG. Why even continue making this a "we vs GOOG" battle when it's clear MSFT isn't in the same league? If you were relatively new to golf and way down the rankings, would you constantly reiterate your goal to beat Tiger Woods? Does it serve shareholder's interests to have the market constantly compare every misstep or minor victory against the backdrop of GOOG and that goal ? It doesn't. We'd be far better off if management made that clear, stopped blindly responding to everything GOOG does, and focused instead on executing their own strategy with more realistic short-term goals - like becoming a relevant and profitable #3.

Meanwhile, MSFT throws in another re-org for good measure. I guess internecine battles are a nice break for the troops from getting killed by competitors.

BTW, If there's some good financial news relating to the AQNT purchase it's this:

The company said the deal would add revenue and operating expense in fiscal 2008, but said it will not change its outlook for operating income or earnings per share next year.

How that will be accomplished is anyone's guess since the interest lost on the $6B - plus integration costs - should eat up any profit AQNT was set to deliver (assuming customers don't balk at the newfound lack of independence) and/or merger cost savings that can be eked out short-term. Presumably, MSFT will be making cuts elsewhere in order to create that result. That said, expect buybacks to slow or even stop on the back of this - at least for several Q's. Otherwise, unless they sell some of their LT investments to help cover this (like maybe Comcast shares now that the latter dumped MS's TV guide?), cash + ST investments will dip below $20B - which would be contrary to Gates' stated preference to go a year w/o any revenue if need be.

Bottom line, AQNT is a great company and should have been acquired years ago while it was still cheap - and when MSFT had already committed 110% to this area. That's what a smart, proactive, management team would have done. Instead, at this price, the sun, wind, and moon, will have to align in order for it to make financial sense. Translated, the current management team who have a brutal record of successfully integrating acquisitions and have shown no aptitude yet in beating YHOO, far less GOOG, are going to have to do BOTH and then some to make it a wise investment.

However, yours truly has come up with the one way in which this deal can make perfect financial sense. Reviewing this must-read article, it's clear that AQNT's chief executive officer Brian McAndrews is a force to be reckoned with. And since MSFT is desperately in need of a new (non-inbred) CEO-replacement, maybe he's it. After all, not only did he just out-negotiate Ballmer six ways from Sunday, but over the past 5 years he's managed to reward his shareholders with a 2000% increase in share price versus ~14% for MSFT. $6B for aQuantive? Far too much and almost impossible to reconcile financially. On the other hand, $6B for a new (capable) MSFT CEO who can substitute winning strategies and execution for empty bravado, dubious "investments", and irresponsible spending? Priceless.

Related:

Articles against the deal:

Endless (do a search) - although the market itself is taking it well so far.

Articles for the deal:

Why Microsoft's purchase of Aquantive is So Smart

Update:

Found two more positive articles on the deal - they're proving to be more elusive than MSFT ship dates.

Microsoft Hits A Walk-off Home Run with AQuantive acquisition (courtesy Windows-Now.com)
Why AQNT is worth 2 Times DCLK (courtesy InsideMicrosoft)

Update #2:

Good thing I said the market was taking it well "so far". Berkowitz spoke at a JP Morgan conference today and got killed during the Q&A. Perhaps that's why the stock was off so visibly. Listen to the linked webcast or check out this for some excerpts:

Microsoft exec: aQuantive deal more of a 'merger'

What I'm reading

2007-05-16T15:09:00.000-07:00

I plow through a fair bunch of MSFT-related articles every week. Some become the basis for posts, but most don't and end up in my favorites cache. Here's a sampling of what I'm reading currently in case it's of interest (plus, now I can clean up that cache!):

Positive

Investor Soros more than doubles stake in Microsoft (sounded even better until I read the final "The overall value of Soros' fund, Soros Fund Management LLC, dropped 19 percent to $2.48 billion from the previous quarter.")
SAP gets cozy with Microsoft
Microsoft's Vista Sales Picking Up in Korea (I take the good news where I can get it)
Gates: Vista sales match rivals' installed base (ok, that's a bit better)
Microsoft Touts PerformancePoint, Next-Gen SQLServer at Inaugural BI Fete
Microsoft lifts shroud off Halo 3 to mixed reviews (too bad initial reviews are a little underwhelming - but the game is not finished)
Code2Fame Challenge (smart)
Windows Server Is Coming Home (okay, it's Wilcox so the positive part may not come shining through, but it's a potentially good thing nonetheless)

Negative

Microsoft Details Patent Breaches (that's a lose/lose unless they're prepared to sue and prove it - which apparently they aren't, and sounds a little desperate)
Linus Torvalds Responds To Microsoft Patent Claims (ouch!)
Microsoft: A law firm pretending to be an army pretending to be a software company (more ouch!)
On Microsoft's feeble Fortune-based nastygram to Red Hat (still more ouch!)
Vista's Lessons for Microsoft
Microsoft cuts Windows virtualization features (after already delaying, in part at least, in order to include said features - can you say "create an achievable product spec to begin with?")
Google Patents Video Game Advertising (Huh - maybe MSFT should be reviewing what prior art they got via Massive?)
Computers bumped from top of online sales (not a good trend)
Google admits gunning for Microsoft (I know, world's worst kept secret)
Comcast Cable TV discontinues use of Microsoft Software

Unclear

How satisfied are Microsoft customers? (remember what they say about lies, damn lies and statistics)
Microsoft delves further into manufacturing with Zune plant (solution to the problem or even more money down the drain?)
Gonzales proposes new crime: 'Attempted' copyright infringement (Yikes)
A Monopoly on Desktop and Internet? Why Microsoft Can't Do Everything (some good insight - albeit from disgraced former analyst Blodget)
WMS: PS3 to 'Win' Console War Because of Blu-ray (analyst sees PS3 ultimately winning this round but it being close)
Microsoft and Yahoo: Match or Misery? (for those needing a renewed dose of YHOO/MSFT pontification)

Updating the Record

2007-05-07T22:52:00.000-07:00

I know what you're thinking - two posts in one day? That's right - and still the same low subscription price!

Actually, last weekend after mowing my ~~moss~~ lawn, I checked my blog where one of my adoring fans asked:

What do you think about the stock now? How is it possible that you write long notes about how the stock is busted and how you told us so - but when it bounces back and actually outperforms, you are silent. I guess you just move on to the next topic/rant.

I've been working on a response off and on during the week - and here it is. BTW, I'm thinking they're not going to like that recent Microsoft's $6M+ Dollar Man post either. Nevertheless, the commenter is correct that the stock has performed better of late. To be honest, I hadn't really noticed since I was away for several weeks and it had been lagging badly prior to that. But if you check now, recent performance plus a more favorable calendar compare makes for some marked improvement. For example, when I penned the specific post on which that comment came through (March 08/07), MSFT had underperformed the NASDAQ on every standard time frame up to 6 years - a fact that I noted at the time. But if you do the same compare now, it has outperforming on the 5-day, 10-day, 1 month, 3 month and 1 year views. Progress - undeniable. Like most shareholders, I'll take it. However, it has still underperformed YTD, and over 2, 3, 4, 5, and 6 years. For example, see the 6-year chart below using just obvious peers SAP, ORCL, HPQ, DELL, and the NASDAQ index (adding high-fliers like GOOG, AAPL, CRM, YHOO, or even EBAY, etc. would have made it unreadable given their dramatically better performance) - that's MSFT on the bottom btw:

Also, note that this better performance comes after ~$24B in buybacks Q4/06 to present (including $6.7B in the last Q alone), which sadly has reduced shares outstanding by only 553M thanks to ongoing dilution - aka paying insiders. As a result (and combined with dividends), MSFT's cash+st investment budget has dropped from $34.161B to the current $28.23B over this period. In other words, it hasn't been free.

So while I'm encouraged by the recent improvement, it's hardly something I'm going to dedicate a glowing post to. But keep in mind that I'm a long-term holder - so this was just a recovery to me. If, on the other hand, you're a short-term holder who picked MSFT up last year at the lows after Ballmer's latest disappointment, then you should be ecstatic with your return. As a long-term holder, I'm also cognisant of the fact that even MSFT's prodigious cash position is eroding rapidly under the weight of these massive buybacks - and that's fundamentally not sustainable. So while there's $22.5B left in approved purchases, MSFT will soon have to slow the pace substantially or face taking cash+st investments below $20B (which imo is unlikely). Therefore, at some point the management team will run out of stock Viagra and price will go up or down based solely on real market demand and non buyback-massaged EPS. For it to go up materially, the market will want to see earnings acceleration, evidence that previous "investments" are finally paying off, and/or bold new moves that show this company isn't headed to irrelevance. In other words, all the things they haven't seen much of this decade. Otherwise, do the math on expected earnings times a sustainable P/E (hint: 25+ on EPS growth of 12% likely isn't it), hope the general market doesn't implode and/or MSFT miss their EPS targets, and look forward to a best-case scenario of modest annual appreciation from here consistent with that (with the normal gut-wrenching plunges along the way, and for as long as MSFT can keep growing earnings).

Now, if you ask what has impressed me lately? What is worthy of a positive post and gives me some optimism that maybe, just maybe, this ol' dog may have some hunt left in it after all? It's this: Silverlight. Way late, but finally some evidence that MSFT is prepared to embrace and go after the Web opportunity versus ceding it to Open Source, Adobe, etc., while busying themselves defending - not very well - the desktop cash cows.

Alas, others are far better qualified to blog about it than I am. So see sample coverage here:

Or just ~~Google~~ Windows Live it. :-)

Update: Added a 6-year chart and related commentary.

Update 2: Corrected some numbers based on commenter feedback and review of the 10-Q.

Microsoft's $6M+ (Per Year) Man

2007-05-07T09:43:00.000-07:00

Okay, you may be too young to remember the TV show The Six Million Dollar Man, starring Lee Majors (former husband of formerly gorgeous Farrah Fawcett - first pin-up for every guy my age). But this post isn't really about old TV series trivia anyway. Instead, the focus is once again on MSFT's Entertainment & Devices Division and its president Robbie Bach.

Readers of this blog already know that I'm not a fan of the Xbox business; Great console, world-class stupid business investment. There was a time when I actually had to justify that opinion. Today, it's the mainstream perception based on results (or, more accurately, lack thereof) and you can find others making the case routinely:

When Will Microsoft Own Up to the XBox 360 Bomb?
Japanese Failure Dooms Xbox 360 (same guy, less detail)
A modern-day Gerstner is needed to cure all of Microsoft’s ills

However, what bothers me more than the massive losses to date, likely inability to ever return an overall profit as a result, and missed alternative opportunities, is that Xbox is constantly cited by MSFT management as a "success" and its leadership rewarded with even more responsibility. For example, Ray Ozzie is quoted in a recent Wharton interview (an otherwise thoughtful and highly recommended read btw) calling it "fairly successful", and goes on to say that:

When all was said and done, [these threats] ended up making the company more resilient.[For example,] in the PS2 competitive realm with Sony, our whole entertainment division came out of that one battle.

Er, so shareholders should be happy that Xbox hasn't just lost a ton of money but has also spawned an entire money-losing Entertainment and Devices Division? Um, okay. Even normally level-headed journalist and full-time Microsoft-watcher Mary Jo Foley seems to have bought into this fantasy. Here she is with "Ten lessons the Xbox Team can teach the rest of Microsoft". Hey, I'm sure there's good stuff in there that other teams at MSFT have/could/or should benefit from. But how about the one lesson MSFT's legacy divisions could teach E&D - namely, how to make money?

Meanwhile, Bach keeps right on making promises he has been totally unable to deliver. For example, here's another comically-titled must-read article (right after you read my Repeat After Me, "We're on the cusp of" post):

Microsoft Poised to Rule Entertainment, Devices World

In it, while Bach waxes poetic about the future, the interviewer manages to slide in "When do you think Xbox will be able to contribute a billion dollars to Microsoft's bottom line, and how?". Hey, good question. After all, at that impressive rate of return it would take just five more years for Xbox to...well, to almost break even since inception. Eight paragraphs later (you gotta read it - it's funny stuff) we get Bach's [effective] answer:

So, it's a business that will be profitable next year—we'll make money next year and that will be the first time, which is pretty exciting. And then the next two or three years are the place where you need to make tracks, and the next two or three years are where you have to make money.

In other words, beyond the vague "2008 will be profitable" assurance (now that the previous 2007 - itself a revision - came and went), he gave no answer at all. But hey, they've only lost $5B+ since 2001. So why would anyone expect or - gasp - demand some greater visibility and accountability at this point?

Bach is on a roll though. Here he is again, this time providing his thoughts on Wii (and PS3):

"It’s a very nice product, but it actually has a relatively specific audience and a fairly specific appeal, frankly, based on one feature, which is the controller itself," he said, as quoted by GoNintendo. "And the rest of the product is actually not a great product—no disrespect, but … the video graphics on it aren’t very strong; the box itself is kind of underpowered; it doesn’t play DVDs; there are a lot of down-line components [that] aren’t actually that interesting."

Don't know about you, but I'm actually starting to feel sorry for Nintendo after reading all that. Hmm...maybe we should review how this sad little product with minimal appeal is doing outside of Bach's mouth - like say, in the marketplace:

Tokyo (Japan) - In one of the most amazing turnarounds in gaming history, Nintendo has seen its net profits grow 77.2% to 174.3bn yen ($1.4bn), beating financial analysts expectations, and its sales grow 90% in the year to March on the back of the runaway success of its DS and Wii gaming systems.

Oh, so they have already achieved what has eluded Bach et al for 6 years? But wait, what about unit sales? I mean, the first person to 10M units (MSFT's Xbox 360) "won" right?:

The Wii has sold 5.84 million units in the year to March, and Nintendo expects to sell around 14 million in the 2007/08 financial year.

Hmm..looks like no one told Nintendo they were meant to give up. Game over. So now they're currently on a much steeper adoption path than Xbox 360, outselling it every month, and are poised to surpass it in total unit sales sometime next year (assuming no change of trend) - all while doing what the Xbox hasn't: be profitable. Perhaps MSFT should have come out with a limited product with limited appeal too? BTW, see the lesson which Nintendo understood and executed brilliantly but which seemingly still eludes Bach (and most of MSFT's current management)? When competing against an entrenched competitor it's not good enough to offer a product that plays just to their weaknesses. The latter can be easily addressed (assuming the competitor isn't destracted or clueless). You need to have a product which plays to the weaknesses inherent in your competitor's strengths. That way, even if they could copy you they likely won't, as it would adversely impact their real or perceived strengths too dramatically.

Bach isn't done though. This time, he's pumping Windows Mobile. Coincidentally, this is occurring just as the iPhone nears market availability and MS "leadership" right up to Ballmer seemingly can't shut up about how it won't take major share - but "may make a lot of money" (isn't that like the goal?). And we know from actual market share data that Mobile is a distant third to Symbian and [much less so] Linux, respectively. But Bach sees an inflection point and it's...well, it's just ahead of course:

After years of struggling to gain momentum, the business is finally at a tipping point, Bach said in an interview."Three years ago, I could walk through Microsoft halls and see Windows Mobile phones. Now, I can walk through any airport in the world and see Windows Mobile phones," said Bach, in Las Vegas to speak at two Microsoft developers' conferences.

Hey, who needs market share data from recognized industry sources when you've got anecdotal evidence like that? He continues:

Bach, who is one of Microsoft's three business presidents, said he expected that figure to more than double to between 10 million and 11 million this year before doubling again to around 20 million handsets in the 2008 business year.

Of course, Bach also famously said (about Xbox) that MSFT doesn't go into new areas "to lose money for years", that Xbox would sell 13-15M units by the end of this year (before revising it down to the current 12M - even that is going to be a challenge based on last Q's sales), and that Zune would be great.

So how much does Bach make for this track record of accomplishment? There's no data available to check back to 2001 - which is unfortunate as it would have made a nice overlay with Xbox's $20B+ invested and $5B+ lost during that period. But in just the past two years since he's been President of the division, Bach has made ~$4M+/year in grant/option sales and what I would estimate to be another $750K/year or so in salary and bonuses. Not up to $6M+/year you say? Well, you need to add in the 328,250 shares he got in August of '06 for doing such a bang-up job. Approximately value at that time: $8M - but it was part of the 3-year SPSA pork barrel and "only" $2.8M of it vested immediately. So there you have it: $6M+/year for an executive who oversees a division that had cost shareholders nearly $2B in losses during the past two years alone. In passing, I see that Bach has a degree in Economics and an MBA. Surely in one of those two he was exposed to the concepts of "opportunity cost" and "net present value"?

Thinking about this and MSFT generally, I'm reminded of the tag line from the Six Million Dollar Man: "Gentlemen, we can rebuild him. We have the technology. We can make him better than he was. Better...stronger...faster." Sounds great - let's start with a new bionic E&D arm...

Show us what you've got

2007-04-25T14:44:00.000-07:00

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 posts higher profit on strong MacBook sales

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:

Nibblin' on sponge cake

2007-04-23T12:09:00.000-07:00

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?:

Google beats Microsoft, Coke in brand stakes

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:

Oak Value Fund: The Long Case For Microsoft

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.

For want of a shoe, or time for a new rider?

2007-03-26T23:05:00.000-07:00

A MSFT-employee recently challenged me to discuss what I would change at Microsoft. I have provided that commentary many times over dozens of posts on a topic-by-topic basis. However, doing it as a subject unto itself is new - and pretty daunting given a company the size and scope of MSFT (Indeed, as you'll see, I think that breadth is one of MSFT's major problems). There is also the immediate issue of determining whether you think the problems are a result of strategic shortcomings, or tactical ones. For example, while Benjamin Franklin was undoubtedly correct when he said:

“A little neglect may breed great mischief: for want of a nail the shoe was lost; for want of a shoe the horse was lost; and for want of a horse the rider was lost.”

It's also true that the right rider can make all the difference in the world. A relatively recent case in point: HP under Mark Hurd versus Carly Fiorina. While I was no Fiorina fan, given the rapid turnaround, it now seems apparent that the company must have been in better shape under her tenure than it appeared to be at the time - but it took Hurd to bring that out.

So, let's begin with the strategic:

Mission

MSFT does not appear to have a clear, honestly customer-focused mission that is understood at all levels. Importantly - and perhaps as a result - employees seemingly aren't in total accord or fully bought into it. If MSFT truly believes in "Your potential. Our passion", then it needs to do more than just pay lip-service to it. It needs to open itself to all that that entails (cross-platform support, not playing lock-in games, etc.) and deliver against it. If they do that, then most employees probably would be fully on board (i.e. maybe the problem is the current gulf between words and actions). Those that wouldn't be, need to go.

Leadership

Seven years have passed since Ballmer took over as CEO, and that's more than enough time to make a fair assessment of his performance in the role and suitability to continue. While he's off the charts for passion and desire, and has done a good job growing the top line (and, much less successfully, the bottom one), overall it's been a mixed bag at best, and abysmal at worst. In particular, I think Ballmer lost the confidence of the street - and maybe employees too - long ago. In my view, it's therefore time for a change. Moreover, it's time for an external hire to fill the role. MSFT needs someone with a fresh perspective, versus someone closely intertwined with the past and what used to work. Assuming Hurd can't be lured over from HP (which is probably true), Oracle's Safra Catz or YHOO's Susan Decker might be good candidates. But I don't mind if that new CEO has a previous MSFT pedigree. That may even be wise, especially if the individual saw what was coming more clearly and, in classic MSFT politics, got pushed out for making too many waves. Brad Silverberg, for example, comes to mind (interestingly, he was also one of the financial backers in Tellme, which MSFT recently acquired). Perhaps there are others even more suitable.

Culture

I see two concerns here. First, the need to move from a culture of "good enough" to one of "excellence" and "insanely great". I've posted about this before. MSFT has a long-standing approach, ingrained via Gates, of getting something - anything - out to market and then fixing it over time. That worked well for a long time when "free" alternatives weren't prevalent, and when competitors/markets weren't moving as quickly as they are today. Now, it's a lot less successful, and yet MSFT continues to do it and be surprised when it fails. This is an area where Apple's Jobs seems to get it, while MSFT appears clueless (and no, I'm not a MAC fanboy - just calling it as I see it). The second area of concern, reported in many sources and evidenced in comments on Mini-MSFT, is MSFT's "cult of personality" versus a true meritocracy. This is truly dysfunctional, and seems to have resulted too often in the wrong people getting ahead or staying, while other [more capable] individuals have been passed over, left, or been forced out. Again, it's impossible to ignore that the culture which currently exists requires Ballmer's tacit approval, if not his full support. It needs to end and ergo, again, he needs to go.

Training

What is MSFT's process for ongoing training and development? Does it exist? Especially within the leadership ranks, it appears to be ineffective or non-existent. Microsoft should put more cycles into trying to create a successful management development curriculum patterned after GE's highly regarded program. Obviously, it will have to be customized, but it's not a coincidence that many, many former GE senior executives go on to be CEOs of other major corporations. How many ex-MSFT senior executives have done that? One, if we count Rob Glaser at RealNetworks? Maybe this process has begun - I don't know, but the results aren't yet evident in overall execution.

Rewards and Punishment

MSFT's reward structure seems to be inconsistent, inequitable and disconnected from the things that drive shareholder value. A leadership team who misses their own earnings goals, for example, should not be eligible to earn 100%+ of their $1B SPSA bonus payout - period. While each group should have metrics that are unique to their business, certain core objectives - like earnings -should span all units and act as global multipliers. In other words, miss your earnings objective, and your entire bonus will be impacted regardless of how well you did on other non-core metrics. MSFT also needs to review the skew between the "top 500" - now morphed to 800 or more given MSFT's ongoing bloat - and everyone else. IMO, it's unjustifiably high. Since overall results don't support increasing the size of the pie, it's time to start allocating it more evenly with those who actually do the bulk of the work. Finally, punishment goes hand in hand with accountability. Sadly, it's been non-existent - at least at MSFT's executive levels - for most of this decade. Recently, we've seen some improvement there, but even then it's often late and mired in uncertainty (e.g. was the executive fired or did they quit?). Punishments, like rewards, should be clear, timely, and leave little doubt about why they're being doled out

Prioritize/Focus

Stop fighting major wars on multiple fronts simultaneously. It is simply ridiculous for current management to assume that MSFT can fight the biggest and best companies on earth, across a dozen or more battlegrounds, and still hope to prevail. Just take a look at some of the folks MSFT is going up against: SONY (and Nintendo) in gaming, Nokia and many others in mobile, GOOG and YHOO in Search, Everyone from Alcatel to Siemens in IPTV, IBM/Oracle/SAP (and smaller players Salesforce.com. Rightnow, etc.) in ERP and CRM, IBM/Adobe/FOSS in middleware and development, AAPL and most of MSFT's former partners in mobile media, AAPL and GNU/Linux in Operating Systems, and FOSS in personal productivity. Worse, these battles are spreading MSFT too thin, and leaving its core cash cows increasingly vulnerable (would Vista have taken 5 years to develop if management hadn't been distracted with a dozen other battles?). MSFT needs to prioritize the current list down to something more realistic, while ensuring that the appropriate vigilance is maintained on the crown jewels. As a start, any new battle should require them to give up an existing one. Notice how that NEVER happens and they're always additive instead?

Better together

Put "partnering" back in Platform. Windows and Office (to a lesser extent) have been successful historically not just because they were decent products, but because they provided a platform for others to develop on. Today, MSFT is increasingly competing against many of its former partners. If you were SAP right now, would you be putting more resources into Windows/SQL/Office, or looking to Linux/mySQL/OpenOffice? Where is Adobe putting an increasing amount of its efforts now that MSFT is competing against them in numerous categories? Ditto, CSCO? Ditto, far too many suppliers imo. If Windows and Office - not to mention most "for-profit" s/w offerings - are going to continue to succeed against increasingly functional low or no cost alternatives, its going to be on the overall platform experience and not the features of any one product. Otherwise, it's just a matter of when, not if, OSS alternatives become good enough in each category to supplant the incumbent (some argue they already are).

For-profit suppliers need to wake up to this bigger threat, and MSFT needs to get back to its roots of providing developers with the preeminent platform for adding value to other's solutions - not cherry picking them off one by one when they establish a market that gets large enough to attract MSFT's competitive interest. I'd also like to see more cross-promotions of mainstream offerings (i.e. not bundled "craplets"), and a global Window-update equivalent (like Linux/FOSS has via "apt-get" and associated GUI front-ends like the Synaptic package installer). Does it really make sense to have half a dozen separate updaters running on my PC - each with its own GUI, process and quirks? If there's a Windows anti-trust concern, make it a Live service. While you're at it, throw up a Live service to clean the craplets off new PCs automagically - the out-of-box customer experience there is terrible (yes, this is primarily an OEM-initiated problem, but since they're not economically inclined to fix it, offer a service which does - it's in MSFT's best interest).

The LBU - Linux Business Unit

Yup, time to face the music and stop pretending Linux isn't here to stay. Not only is it, it's likely to eventually gain a significant share of global desktops (read: eventually much more than AAPL). So why is MSFT resisting it so hard versus simply embracing it as yet another opportunity to sell software a la the Mac Business Unit? IMO, MSFT should be focused on what it can still sell accounts who go this route. At a minimum, that could include Servers for legacy support of Windows apps. But maybe MSFT should even develop it's own "customer-friendly" linux distro (or, if GPL exposure of that code is an issue, maybe a non-GPL licensed library to run on any distro, or a BSD-based distro)? BTW, if they haven't taken steps to at least determine the engineering feasibility of that and effort required, then they're not doing their job. Additionally, why make it a religious battle? Like any OS, Linux does some things very well. For one, it's much more modular than Windows. So why not empower an internal group to promote it where it might make sense - like say in a set-top box or audio device? The Novell SUSE distribution thing is a step in the right direction, but MSFT needs to do more. Heck, if it can't convince itself that the Windows kernel and architecture is superior - and I can't find a single analysis that argues that's the case (company published or otherwise - if you have one btw, I'd be interested in a link) - maybe it should do an AAPL, hop on board a Mach/BSD kernel, and add value at higher levels only moving forward?

Investments that make money

Duh, you say? Well consider that despite years - or in some cases decades - of effort and $10B's spent, MSFT's emerging business "bets" are STILL collectively unprofitable. Business can and do make investments for a variety of reasons. These include generating an ongoing stream of earnings, creating a asset which can be sold to realize a profit, protecting an existing earnings stream, and ensuring access to a future one. MSFT's problem is that almost all have been sold to shareholders and the market as the first, but have failed miserably to provide a return. While execution blunders and other mistakes have normally been a contributing factor, it's becoming increasingly apparently that either management plans to ignore that, or their actual goal was always defensive versus offensive and they simply misrepresented their original intent. IMO, either of those options is unacceptable.

Research and Development

MSFT spends a ridiculous amount of money on R&D - as they're happy to point out at every opportunity. How much? About $35B since 2000 (more than IBM, and more than SONY/GOOG/AAPL combined). What they don't like to talk about, is how little of that is the "R" part (only $500M or so annually). In other words, it's mostly development costs masquerading as R&D for tax purposes and to maintain the fantasy that maybe it's mostly discretionary. More importantly, like the "investments" above, you rarely hear details on the return being generated. Either MSFT needs to figure out a way to better tap the ideas coming out of the MSR brain trust, or maybe it's time to disband that group like Apple did. Someone then needs to look at that overall Development cost and figure out why it's so large. To put it in perspective, AAPL has spent less than $5B on R&D since 2000, yet doesn't appear to be lacking for either innovation or development. Indeed, they seem to be kicking MSFT's butt at both, resulting in larger returns, much quicker paybacks, and faster growth. Fixing this obvious imbalance, would likely be the biggest single contribution to accelerating earnings that any new CEO could make.

Mergers and acquisitions

MSFT's track record in this area is mixed to horrible. In most cases, the acquired company's products have either disappeared completely or been incorporated into some other offering. Additionally, the size and scale of these acquisitions have been very modest relative to MSFT's size and cash position. IMO, that's overly-conservative. I've posted before that MSFT could - and should - have done more at the bottom of the dotcom/market bust when the who's who of technology were trading at pennies on the dollar. I view this as one of the largest single mistakes of Ballmer's entire tenure - and there's no shortage to choose from. Even today, he is routinely quoted as stating a preference for many small acquisitions versus a larger one. Then why carry that much cash on the Balance Sheet? Is MSFT a bank? While larger purchases bring with them more integration risk, and MSFT hasn't exactly blazed a trail of success on smaller ones, companies like HPQ and Oracle are demonstrating that the widely-held industry perception of larger acquisitions "never working out", may not be true. As a result, I think MSFT needs to get more aggressive in this area and better at it. The recent Tellme acquisition is a positive step in the right direction - at least it's bolder. But MSFT needs to figure out how to successfully leverage new acquisitions a la the recent EMC/VMware model, versus doing their usual borgify and ultimately destroy. Again, one of the core strengths of a new CEO should be a demonstrated track record of M&A success.

A truly global structure

Don't just talk globally, act globally. While growth is increasingly shifting to emerging markets, and MSFT talks up the opportunity, it continues to be hugely Redmond-centric. Yes, the company has established some foreign labs, etc., in recent years, but it still pales by comparison to the market opportunity or similar large global entities like IBM or HPQ. MSFT sells decentralized computing but acts more like a mainframe. Time to push more and more operations overseas where the growth is, and where the greater talent pool exists. IMO, had MSFT done more of this sooner - like in Europe, for example - they also wouldn't be perceived as such a US-entity, and would be better embraced by foreign markets (and especially Governments) as part of the local community.

Oh, and freeze Redmond headcount (except for select strategic initiatives) for at least the next two years.

Marketing/Sales

Marketing and Sales needs to become world-class. I'm not sure MSFT ever was a leading marketing or sales organization - although in the 90's, when things were all going the company's way, the perception was that they were incredible. Frankly, I think IBM, Oracle, HPQ, SUN, etc. were always significantly more experienced in selling to the enterprise and maintaining high-level relationships. And in the consumer space, which is increasingly important, MSFT is getting beaten hands down by AAPL and many others. Again, that needs to change. On the consumer side, MSFT needs a new advertising company pronto and/or new executive oversight. For every one good ad/campaign, there are ten bad ones. They also need help with product design, packaging and especially naming. On the enterprise side, I'm not sure whether the solution is new training, new recruitment, or new leadership - probably all of them.

Public Face

I am sick and tired of MSFT executives "trash" talking competitors in public. This is such a fundamental business tenet that it's an embarrassment to have to even list it. But Ballmer and Gates were apparently asleep the day everyone else learned it. Moreover, others throughout the organization appear to key on this and feel empowered to do likewise. It needs to stop and asap. Be judged by your products, support, and execution - not your mouth.

Put the fun back into computing

Somewhere along the line, MSFT seems to have fallen into the IBM trap of trying to please corporate IT departments instead of users. To do so, imo, is to forget the lessons of Windows 95. Windows 95 was a hit not because IT departments demanded it - they didn't. It was a hit because users embraced it and then demanded it at work. I recently loaded Vista, which I may post about, and liked it overall. But there was very little "Wow" - certainly not enough to justify upgrading my existing machine and purchasing the retail version to get it. Which makes the advertising campaign that much more ridiculous. Underpromise and overdeliver - another basic business tenet that MSFT routinely ignores. My advice? Get a feature pack (and not just a service pack) out asap. Beyond that, get back to making computing fun for users.

Okay, now on to the more tactical:

Windows

Sending in Sinofsky to clean house and get this division back on track, was smart and way overdue. IMO, Allchin and others should have been fired during the Vista reset fiasco - but undoubtedly Gates fingerprints were so prevalent in that screwup that sending others packing would have been the height of hypocrisy. As above, I think Vista is just "good". So much for Ballmer's "It'll be great - bet on it". That's pretty unacceptable after all the time and money spent, and it's going to make it that much harder to sell (all PR puff pieces about exceeding initial XP sales aside). Stepping back, I think the writing is on the wall that MSFT needs to develop a cloud-type hybrid OS that lives on both the desktop and server. Others already are, via companies like this (sporting ex-MSFT distinguished engineer Lou Perazzoli, and ex-CFO John Connors as an investor) or via technologies that promise a similar experience - like Adobe's Apollo. It would be nice to think that MSFT is way ahead of the game on this, especially given how core it is to the business and how far along others appear to be. Sadly, based on this and this, it sounds like they're late to the party yet again.

I also think MSFT has to decide whether it can continue to compete while dragging several decades of legacy code with it. Backwards compatibility is something that MSFT can be justifiably proud of. But moving forward, I don't see how the company can keep up with AAPL and Linux with the current code base. Pretty obviously, MSFT needs to be in a position where it can come to market much faster with new releases than it has done. In particular, I think it needs a consumer release that is a perpetual showcase for innovation. This addresses the more "fashion" orientated demands of this increasingly important market segment and, like Windows 95, would keep IT departments on their toes via end-user demand. All due deference to the more modular approach of Vista, I just don't see that being sufficient to enable this. Now, I don't profess to have the technical answers here, but all options - from new "cloud" OS, to dropping some legacy compatability and/or embracing a new kernel and leveraging higher-value layers only (like OS X) - should be on the table.

Business Division

Now that Raikes has finally woken up to former GE CEO Jack Welch's "when you think you've reached saturation, expand the market definition", I think the Office group is on the right track. If they can do a good job of that via telephony, etc. then justifying the additional cost of Office should be viable - assuming you get the world-class Salesforce in place that I discussed above. I also applaud the boldness of the new "ribbon" interface. I haven't completely made up my mind on it, but that took guts. Kudos.

On the ERP/CRM side (formerly BusSol), I think this group will never be the market leader as long as its mandate is polluted by trying to be an Office-delivery mechanism versus the world's leading ERP/CRM solution. In my mind, now that the moronic decision to go head-to-heard against previous partners has been made, this group should be free to pursue that objective 100%, including supporting OpenOffice front-ends, non-SQL RDBMS, etc., when and where that becomes desirable (if it isn't already).

Finally, given the renewed focus on Healthcare (which I agree with), I would seriously consider buying a large Healthcare software supplier that would be accretive - like Cerner. If you're wondering about the apparent contradiction there, I don't see that being as aggressively confrontational versus existing partners as were say, the ERP/CRM moves.

Server & Tools

This is a group that imo can be justifiably proud of their record of accomplishment. Yes, SQL suffered a huge delay. Yes, Exchange faces some imminent threats from OSS and needs to get easier to manage for larger entities. Yes, Home Server has some work to do. But quarter in, quarter out, this group has an excellent track record of profitable growth despite being in the direct line of fire from Open Source alternatives. It's going to take a lot to stay that way and adjust to the whole SAS model, but they seem up to the task.

Online Services

Let's face it, MSN has been an abject failure. Indeed, outside of IPTV and MSFT's $10B of failed cable investments, no other group in MSFT has burned through more cash, over a longer period, and still had losses to show for it. WRT the more recent efforts here in Search and Advertising, those too have been massive failures. Again, that's not just my assessment - it's the assessment of professional analysts whose opinions I have quoted on several occasions. As a result - and as I posted here - I think MSFT should give the current team until year-end to show the beginning of a turnaround. Recent monthly stats provide some reason for optimism in that regard (the ongoing market share losses having been arrested, at least temporarily), and I have confidence in at least Berkowitz. But if they can't show progress by then, it's time to pull the plug and outsource the entire effort to YHOO in return for a % of the action.

Entertainment and Devices

Why is MSFT in the device market? If they are going to be in it, shouldn't there be a plan to be #1? If so, why didn't they buy Logitech at some point? I mean, if you're going to tank overall margins with hardware anyway via Xbox, why not do it with something profitable? WRT that bigger concern - Xbox, what can I say that I haven't said repeatedly before? It will likely take multiple decades, if ever, for MSFT to recoup the $5B+ expended on Xbox to date. Additionally, it would be hard to find a buyer given that profit picture and the massive losses generated on each console rev. I also think MSFT's current management has no intention of selling it. As a result, Xbox is a financial failure by any reasonable overall assessment. That said, the $5B is now a sunk cost, and if leadership is convinced that future losses can be mitigated and a [ongoing] profit generated, then it makes sense to continue forward. Gaming is big business overall and I think MSFT needs to be represented. It should just have been done in other ways, and imo MSFT stupidly neglected the PC-gaming market in the interim (an oversight which, thankfully, appears to be getting addressed). What doesn't make sense is to pretend that Xbox has been a success or even a "great success", or to give the executives involved - many of whom are the same geniuses who predicted 2-3 year paybacks back in 2001 - more responsibility. Oops - too late - Zune.

Conclusion

Those are some of the issues as I see them - strategically and tactically. Again, I don't profess to have extra insight, nor do I think I have all the answers - or even any of them. At the same time, I'm not splitting $1B in bonuses with 800 other senior colleagues because of my supposed world-class brilliance. What I am, is a shareholder who has held an underperforming stock for this entire decade, while the current management team has been telling me to "have patience, our plan is working". It isn't, and it's time for someone new to come in, acknowledge that fact, and start making the tough choices required to get things back on track - or at least fail trying.

Update: Various articles that touch on the themes here in some way (i.e. directly or indirectly):

I've fallen and I can't get up

2007-03-08T15:17:00.000-08:00

I may be dating myself, but remember that commercial? Well, it certainly seems to fit MSFT. In a Feb 28th post, I asked:

"Given the series: $31-$30-$29-$28, what might logically come next?"

Today, several reporting services (NASDAQ, Investor, etc.) have a low on MSFT of $26.60 - although the charts suggest that might have been a bum trade and it was really around $27.27. Regardless, we're close to the "$27" I had implied in the quote above. It also came amid an escalating slide relative to not just itself, but the market. MSFT has now clearly disconnected from the latter, forming what is called a "negative divergence". That does not bode well.

On a daily basis, I track some 20 stocks. For most of today, only two were negative - MOT and MSFT (though that has moved to 5 by EOD). Here's the chart for MSFT:

Note: that's actually a bit off due to timing/charting issues on Investor. MSFT actually closed down more than 1.05% in a market that was up .55%. And it came on above-average volume - again, not good.

In that same post, I went on to say that:

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.

It's still unclear whether the market is going to find support here or not (and we're getting close the "sell in May and go away" adage), but I stand by my earlier assessment. If MSFT can't find some relative strength here ASAP (like tomorrow - which will be tough given that it's a Friday), it is definitely at risk of dropping its 200-day moving average - and convincingly so. Based on the continued and even accelerating weakness, the market seems to know something we don't. Is more bad news on the way?

BTW, quoting my previous comments isn't being done to say "good call Extrememakeover". First of all, I've made plenty of bad calls. Second, that's not my style. Third, I'm sickened for all shareholders who have once again seen the value of their holdings plummet - myself included. I offer them up instead, merely to provide a context against which you can judge my current comments, as well as on the off-chance there's anything of value for your own MSFT investment strategy.

Now, any stock can have a bad day. This isn't about that - so save me the comment complaint. The chart above, however, would yield the same net result - underperformance versus the NASDAQ - if currently drawn over:

5 days
10 days
1 month
YTD
3 months
1 year
2 years
3 years
4 years
5 years
6 years

If you don't believe me, try it yourself (posting separate charts would have taken too much space). In fact, let's look at how the stock has performed this entire decade so far:

BTW, the red line is the NASDAQ and the black one is MSFT - in case it's not easy to read.

An employee commenter recently suggested we should all be used to this by now, and wondered why I'm harping on it. The former is obviously true, but I reject the logic implicit in the latter. As investor owners, it is our right to communicate our dissatisfaction with current management's track-record. In particular, because that record is one of abject failure to drive realizable shareholder value - as detailed above. In fact, as a shareholder, I'm embarrassed that we haven't been more vocal (as a group) in expressing our concerns. Had we done so earlier, changes might have occurred, and we might not have gone this decade (so far) underperforming the market. But sadly, much of MSFT is held by large institutions who, unlike you and me, can invest in complicated hedging strategies to mitigate the underperformance or even benefit from it. Many are also forced to hold MSFT because they track the indexes in which it is a prominent member (especially the S&P). However, there are signs that even this group may be tiring of holding a stock with such an abysmal performance record - they actually being rated on their results.

Of course, the usual Ballmer apologists will come out of the woodwork and talk about the need for "patience". They'll talk about how you have to focus on "managing the business" not "managing the stock". The more analytically inclined, will add that MSFT got too expensive during the late 90's (at least when growth subsequently fell off a cliff), and that this extended period of stagnation has been about "restoring fair value" or "growing into its market cap". Still others - convinced this is all an anti-MSFT conspiracy - will tell you it's because the market just "hates" MSFT and is therefore ignoring what Ballmer has managed to accomplish. And then there's the company's many detractors, who will wade in with "Duh, the company's best days are behind it" or, more likely, something less eloquent and more juvenile like "that criminal, monopolist felon M$ is screwed". There's at least an element of truth in most of these. However, I don't think any of them goes to the heart of the matter.

WRT "patience", that argument is getting pretty tired by now (see above if you're confused). It's also worth noting that, when it came to his own personal investment in Six Flags, Gates himself didn't seem to put much faith in "patience" as an investing premise. WRT focusing on managing the company not the stock, that's clearly true, but then the visible business results of that strategy haven't been overly evident, have they? WRT the "overvaluation" argument, that could be said of most tech stocks in the late 90's (MSFT even missed out on much of the final blowoff because concerns over the DOJ trial were already rising), and yet many have outperformed MSFT in the period since, including Oracle, HPQ, AAPL (don't even look, you'll depress yourself) and many, many others. WRT the conspiracy theory, why "MSFT" (although it is a lightning rod for critics - perhaps a message there), and then why isn't this borne out in the valuation measures? MSFT may be cheaper than some, but it is by no means "cheap" relative to growth, sales, earnings or many other measures. WRT MSFT's "best days" being over, I don't think that's true by definition, but it certainly seems increasingly plausible given the current trajectory. Still, there are numerous other companies who this could be said of, and yet they've still managed to outperform MSFT since '00 - and handily. Example: IBM.

While many of the above have played a role (and add in all the legal fallout), I think MSFT stock has underperformed for several - mostly objective - reasons. In order, these are:

the failure to drive earnings commensurate with revenue (most of the post '00 growth having been of the profitless variety). IMO, this is far and away the #1 reason. To date, Ballmer's "emerging bets" have cost shareholders billions in cash and foregone earnings while collectively failing to pay off at all.
a perception, based on demonstrated execution failures, of a company that is getting weaker versus stronger, and less agile versus more so. Again, many of these are demonstrable and even in supposedly "core" areas of expertise (e.g. Longhorn/Vista).
a concern that competition is getting fiercer and that MSFT is increasingly fighting battles on too many fronts, against too many players, and losing many of them.
a dawning realization that technology is once again going through a major tsunami, coupled with a belief that MSFT is more concerned with avoiding being crushed - or even denying its existence - rather than adapting quickly enough to catch the wave and eventually lead it.
a management team that comes across as largely oblivious to all of this, and by their actions, have made it clear that they are unwilling and/or unable to change course regardless of impact on the business or other stakeholders - especially shareholders.

As a result, the street is losing confidence and - since they figure they can't affect a change of leadership given Gates' and Ballmer's stakes - voting with their feet. That process began when MSFT first disconnected from the market in 2003, and it continues. So far, based on results, the market - and not Ballmer - got it right. Which is why I get irritated - and frankly, insulted - when I read a comment in this article. In it, CFO Chris Liddell discusses MSFT's acquisition strategy. FWIW, on that score, I completely disagree that MSFT couldn't and shouldn't have done more numerous and larger acquisitions (except that they generally suck at it, but that shortcoming needs to be addressed pronto). In fact, when you consider that at the depth of the bear market most companies were trading for pennies on the dollar, and MSFT had the largest cash horde of anyone, why didn't they buy more? Likely a combo of being conservative by nature, but also totally distracted by the anti-trust legal fallout. That's a shame, because it could have been a once-in-a-lifetime home run for shareholders by now. Nevertheless, it's not Liddell's overview and justification of their approach that bothers me, and he even makes a few decent counterpoints. It's this:

It's ironic that we can probably get more of a pass from our shareholders at spending $5 billion on an acquisition if there's a very strong short-term impact than having a $2 billion R&D spend over the next three years, which may have the same impact.

Chris, did you accidentally swallow the [Matrix's] blue pill instead of the red one? If so, wake up and face the truth. It's not ironic at all. It's a reflection of the pathetic track-record of driving shareholder value that I've discussed above. Against that backdrop, shareholders are naturally more inclined to give you a "pass" on doing something - anything - new, versus continuing to do what clearly hasn't worked for shareholders this entire DECADE. Indeed, why you and the rest of the management team assume you don't have to justify a continuation of business-as-usual and your previous/current/future investments, and are seemingly taken aback when you are even asked to do so, is really the only thing that is ironic - or just plain ignorant.

Update: 3/13/07 - The 200-day moving average was officially broken today. Despite the extreme selloff YTD, the stock still managed to end on its low, underperforming the NASDAQ - again - in the process. News about another potential DOJ investigation didn't help, and the market didn't appear to like the potential Tellme acquisition. Next likely stop is low $26's or high $25's. If that doesn't hold, the 2/3 retracement level mentioned in the post - $24.74 - would be the next logical target.