Eight Years of Wrongness

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

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:

• Microsoft's Revenue, 4Q Outlook Disappoint the Street
• Microsoft quarter view disappoints, bullish on '09
• LIVE ANALYSIS: Microsoft FQ3 Weaker Than Expected

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?

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"

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:

• Microsoft Changed Vista Rules for Intel, E-Mail Says
• Microsoft Combined With Intel For A Vista Logo Disaster
  
• Why Did Microsoft Favor Intel Over Users?

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!

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

• Vista SP1: The hits just keep coming
• Windows Vista SP1 To Break Apps Just Like Vista Did!
• Wave goodbye to Microsoft’s Windows Anytime Upgrade
• 50 Reasons to Switch from Microsoft Windows to Apple’s Mac OS X
• Microsoft class action suit over Vista approved

Home Server

• Windows Home Server Still Crippled By Corruption Issues

Live

• Why Ray Ozzie can't save Microsoft

Office/CRM

• Document format battle takes shape ahead of meeting
• Microsoft: IBM masterminded OOXML failure
• The Smartest Unknown Indian Entrepreneur

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

• Apple beats Microsoft, Motorola in Q4 phone sales
• Screw Windows Mobile, I'm Getting an iPhone
• For Microsoft: Danger, indeed
• The Spectacular Failure of WinCE and Windows Mobile

Marketing

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

Legal

• Microsoft move doesn't solve product-tying issue - EU
• U.K. will investigate Microsoft for consumer rights violations

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?

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

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.)