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Microsoft Corporation (NASDAQ:MSFT) was one of the worst performing tech stocks in 2012. Its stock was down 21 bps in 2012, and on a dividend adjusted basis, was only up 262 bps. The strength of this company lies in its diverse product lines. It supports five operating segments and a corporate segment. These segments should be valued separately, especially with all of the recent talks about company break-ups. This is not to say that MSFT should break up into separate parts, but is a way for investors to see what each segment is really worth to MSFT. The five segments it operates in are: Windows Division, Server & Tools, Online Services, Microsoft Business, and Entertainment and Devices. One way to try to value each segment is on a P/S basis.

Windows Division

This segment used to be one of MSFT's bread and butter. Its products consist of Windows 7's operating system, Windows Live, and PC hardware products (Source: 10-K). The segment's sales and operating profit margin (OPM) are shown below (Source: Capital IQ):

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MSFT competes against Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) in this segment. Both of these competitors have gained competitive advantages against the company, as there is a social and corporate trend away from typical MSFT operating systems. For this method, I used management's guidance and a regression analysis to forecast sales for each segment. For the multiples used, I used the average of the segment's group. GOOG was left out of this segment due to its much higher valuation, which is inconceivable for MSFT going down the road, and the higher similarity with valuation to AAPL's iOS system. The valuations are shown below (Source: Capital IQ):

With 68% certainty, I can assume the correct multiple for MSFT lies between 3.09x and 5.12x sales. With declining operating margins and slower growth sales, MSFT should lie at the bottom of this valuation at 3.09x sales. The calculations for the fair value based on trailing twelve month data and estimates for next December's results are shown below:

Server & Tools Division

The Server & Tools Segment is MSFT's second largest segment. Its products consist of the Windows Server operating systems, Azure, SQL, Intune, Embedded, Visual Studio, Silverlight, Consulting Services, and Premier product support services (Source: 10-K). The segment's sales and operating profit margin are shown below (Source: Capital IQ):

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MSFT competes against a wide variety of firms in this space, including Hewlett-Packard (NYSE:HPQ), International Business Machines (NYSE:IBM), Oracle (NYSE:ORCL), Red Hat (NYSE:RHT), BMC Software (NASDAQ:BMC), Intel (NASDAQ:INTC), Salesforce (NYSE:CRM), GOOG, Amazon (NASDAQ:AMZN), and many others. For this method, I used management's guidance and a regression analysis to forecast sales for each segment. As shown, the regression correlation is strong at 98.3%! Management guided for 80% of sales to be in the low-double digits for growth, and for the other 20% to be in the mid-teens. The valuations are shown below (Source: Capital IQ):

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Despite the improving margins in the segment, but a recent lack of barriers to entry and strong competition from current competitors, MSFT should deserve the low end of the range again. This would value MSFT's Server & Tools segment at 3.28x sales. The calculations are shown below:

Online Services Segment

The Online Services segment has been one of the weak points for MSFT, as it has not been able to compete as well with competitors or gain market share. Its products consist of Bing, MSN, adCenter, and Atlas (Source: 10-K). The segment's sales and OPM are shown below (Source: Capital IQ):

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MSFT's competitors are GOOG and Yahoo! (NASDAQ:YHOO). GOOG is the clear dominant force in this search engine space. The valuations are shown below (Source: Capital IQ):

With GOOG's dominance and MSFT's poor OPM, MSFT should have a lower multiple than its peers at 3.44x sales. It even could be justified to have a lower multiple than 2.98x given these two disadvantages it has in the space. It does not materially change valuation all that much though, given the lower percentage of sales than other segments. Using the regression equation and management's guidance of growth like Q2 (roughly 3.2%), the valuation below is obtained:

Microsoft Business Division

This segment is what drives MSFT and will drive it into the future. It makes up the majority of sales and generates the highest OPM. The products consist of Microsoft Office, Exchange, SharePoint, Lync, Visio, Dynamics ERP and Dynamics CRM, and Office 365 (Source: 10-K). The segment's sales and OPM are shown below (Source: Capital IQ):

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The segment's competitors are GOOG, AAPL, Adobe (NASDAQ:ADBE), Cisco (NASDAQ:CSCO), IBM, Oracle (ORCL), and SAP (NYSE:SAP). MSFT's products in this space are dominant, especially in the business and education worlds. There are no products that are truly like Microsoft Office in terms of what it can do for users on a mass scale. The valuations are shown below (Source: Capital IQ):

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Microsoft Office 2013 could merit MSFT obtaining a premium multiple moving forward. However, it is already trading well-below the industry's average over the last few years. This segment could see significant multiple expansion if Office 2013 comes on strong. The problem lies in the segment's correlation to PC sales, which are once again expected to be weak. According to management, 60% of the total revenue for the segment should be low double-digit growth and 40% of it should outperform the PC market. Using the regression equation (which is 88% correlated) and management's growth guidance, the following valuation is obtained:

Entertainment & Devices

Prior to the innovation of smartphone technology, gaming consoles were "the thing." MSFT's products in this segment are the Xbox gaming console, Xbox games, Kinect for Xbox, Xbox accessories, Xbox LIVE, Skype, and the Windows phone (Source: 10-K). The segment's sales and OPM are shown below (Source: Capital IQ):

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The segment's competitors are GOOG, AAPL, BlackBerry (NASDAQ:BBRY), Nokia (NYSE:NOK), Sony (NYSE:SNE), and Nintendo (OTCPK:NTDOF). MSFT used to have a dominant position in this space with the Xbox brand. However, with the trend away from game consoles and towards smartphones, the Xbox line may struggle without any innovation. The valuations are shown below (Source: Capital IQ):

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Given the trend away from gaming consoles, low margins, lack of demand for its phone, and strong market share gains in mobile phones by competitors, MSFT deserves a low multiple of 1.8x sales. Using the regression equation and management's guidance of "low single-digits," the following valuation is achieved:

Non-Operating Segment: Corporate

The Corporate segment will frequently offer discounts or sell directly from its corporate office. Trailing twelve month data shows terrible December 2012 corporate sales results (Source: Capital IQ):

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MSFT tried to offer discounts and stronger promotions to fuel sales growth. With a probable rebound in the Corporate segment and still discounted offerings to gain market share, the Corporate segment will not hurt the valuation of MSFT as much as before. It was valued at the average of MSFT over the time-frame at 4.09x sales:

Total Value

Combining all of the segments together on a fair value basis and forecast target results in the following valuation:

MSFT is trading at close to $28 as of February 11, 2013. Given this fair value and potential target by next December, MSFT is fairly valued here. The dividend yield is attractive at 3.3%, but the stock really lacks a catalyst. With the company being driven mainly by its Business Division, it will need Office 2013 to shine.

Source: A Different Way Of Looking At Microsoft's Valuation