Bullish on Microsoft

Microsoft (MSFT) is of course one of the largest technology companies in the world. Is it the right time for investing in its stock? By calculating the intrinsic value of shares, I believe the clear answer is yes. But what about the business side, and what about its future profits?

Let's focus on the structure of the business. Activities are divided into the following divisions:

1) Client

Operating systems are located under this division. The operating system Vista, which is now a source of income, includes either the standard version, or in the Premium Edition, such as Vista Business or Vista Ultimate. In 2008, it sold 180 million licenses for operating systems of MSFT.

In 2009, MSFT expects greater demand for operating systems to come from retail clients, particularly the growing number of PC users in emerging markets, than from the business sector.

2) Server and Tools
This division focuses primarily on the sale of licensed software for computer servers and networks. It is on both the Windows Server and Microsoft SQL Server. There is activity in this division, which is also known as Microsoft Consulting Services. In 2009, it is expected that sales will increase due to the release of the new versions of Windows Server, Microsoft Visual Studio and Microsoft SQL Server.

3) Online Services and Business
This is not as successful for Microsoft as it is for other companies. This division contains operations from portals MSN and Live Search. The unsuccessful acquisition of Yahoo! (YHOO) brought a lot of discussion. The annual report on the potential acquisition had this comment:

"After careful consideration, we concluded that the price requested by Yahoo! was contrary to the interests of [MSFT] shareholders. We have offered several other suggestions on how to join Yahoo! or engage in joint co-operation, but all these proposals have been rejected [by Yahoo!]. After this unsuccessful acquisition, [MSFT is] still looking for other ways, whether through their own invention, an acquisition or other form of partnership as [a] way to enter into this business. "

4) Microsoft Business Division
This division is responsible for Microsoft Office Systems and Microsoft Dynamic Business Solutions. Microsoft Office makes up more than 90% of this income group. Microsoft Office 2007 licenses are selling very well (yearly sales growth of 21%). There's been a slight decrease (-2%) in sales of Microsoft Dynamics. At present, this is the most critical division of Microsoft.

5) Entertainment and Devices Division
This is again the most dynamic group of all. Development of the Xbox 360 and the development of computer games and video games for Xbox are the activities of this division. In recent years, MSFT has invested large sums in this division and the profitability has slowly turned on its side. Playstation is not as far ahead as it was in the past. In addition to the celebrated successes and sales of computer games from Microsoft, there is a very big problem with piracy.

Financial analysis for Microsoft

click to enlarge

This table shows that Microsoft, despite the global recession, is able to increase its revenue and profit. Profit is over 17 billion USD and it is necessary to say that deserves recognition. A deterrent factor for the shareholders is certainly pay ratio, which currently reaches 24%. This is a little meanness from MSFT, but the segment can still talk about the growing industry. Therefore, I would even consider MSFT a type of growth share.

The good news is that Microsoft was able to use this five-year period to maintain a faster rate of profit to revenue growth. Moreover, the growth rate in terms of the geometric average is interesting at 21%.

The cash that MSFT now holds is far from what it had five years ago. Back then it had an incredible 60 billion USD, which is now something unimaginable. And the 23 billion USD in total deserves respect. Business debts are also totally in check, so from this perspective, it seems to be that everything is alright.

Fundamental analysis for Microsoft

Comments

[prairiedog555:]

I don't know about Microsoft. My software and hardware engineers friends say that Linux and Apple are making serious inroads vs PC OS.
This Vista debacle really is a black eye for Microsoft and my company, (tech Company) is only using XP.

Mar 16 08:28 AM

[William Cowie:]

Historically, MSFT has relied on only one thing to establish growth: aggressive domination.

It has not a single product or service it can point to as proof of innovation. Windows was licensed from Apple because Word and Excel in the early days only ran on Macintosh. Those two programs were bought, not developed. What changes they made were usually driven by competitive pressure. When competition waned, innovation stagnated. There is a long trail of innovators with stories of being bullied by MSFT into either selling or being put out of business. Every single new venture of theirs has met with failure or, at best, mediocrity. This is not a company with any credibility when it comes to any new line of business or innovation.

Customer service certainly has never been a strength.

Therefore, any bullish sentiment can only be based on a new situation where MSFT can force the market to its will. Those situations are decreasing, not increasing.

Therefore, until either MSFT changes its culture of aggression, or a situation arises where we all have to go along with the giant, whether we want to or not, I can see no fundamental reason to be bullish on it.

Mar 16 09:27 AM

[Josh B Thom...:]

"Windows was licensed from Apple because Word and Excel in the early days only ran on Macintosh."
>That logic makes no sense. The word "only" is wrong.

"This is not a company with any credibility when it comes to any new line of business or innovation."
>That logic makes no sense. It is hyper-emotional.

"Customer service certainly has never been a strength."
> I have heard stories to the contrary.

>The overuse of the words "every single", "any", and "only" cause your credibility to low.

Mar 16 10:56 AM

[RattyUK:]

@Josh

Scoring points on pedantry and ignoring what was said - way to go.

For your information Apple lost the Look and Feel case with Windows because the tossers in charge of Apple at he time had a clause which basically said Microsoft could "make use of any innovation they discovered while developing Word and Excel for the Mac." I think that was what he was trying to say.

Mar 16 01:51 PM

[Alex Filonov:]

Online business: 'not as well as others' is a charitable description. I don't know what other company in the world can afford to lose half a billion dollars every quarter on one division, with no end i sight.

Entertainment and devices: not profitable.

I'm bearish on Microsoft. If company was smaller, it could be a great target for corporate raiders. Company would be worth much more if split in 3-4 parts. As is, it's a monster with bad management, which spends money to satisfy their egos. More on MSFT in my blog: muddlinginvestor.blogs...

Mar 16 02:17 PM

[User 296829:]

My comment is related to the customer service issue. I had an Xbox 360 stop working, MSFT sent me a box I mailed it in, they sent me a new one, no charge. My son had a Zune that would no longer accept a charge. I called MSFT, they sent a box, we mailed it in, they fixed it, no charge. I have called the 360 helpline several times, always very helpful. I run MSFT Money, couldn't figure out how to do something, sent an email, got a nice response. I find their customer service excellent when compared to some of the other companies I have dealt with.

As for the stock, I am neutral, they generate a lot of cash, but need to find some growth areas.

Mar 16 02:32 PM

[Ricard:]

I disagree with this one comment. The Office segment is wholly dependent upon the Windows monopoly to rake in profits. Separate the businesses, and sure, they will seem to be more focused, specialized, and hence, more effective, but all segment are dependent upon the OS to survive. Segments that are not are not profitable (Zune, Xbox). That lies in the future for Office if the company is broken apart.

Everything else I completely agree with, along with William Cowie's entire comment. MSFT is the most ineffectual 'blue chip' company I have ever seen.


On Mar 16 02:17 PM Alex Filonov wrote:

> Company would be worth much more if split in 3-4 parts.

Mar 16 02:41 PM

[Chris B:]

Sorry, but I refuse to buy a company that consistently produces inferior products. I know that everyone says MSFT has an unstoppable monopoly, but experience shows that shoddy quality eventually catches up with companies, and those rosy 22% five year profit growth estimates can easily go poof!

Crappy MSFT products:

*Windows (generic): inherently insecure file system, inefficient use of system resources, inherently unstable and crash-prone

*Windows Vista: everybody hates it, enough said.

*Windows 7: even more of a resource hog than Vista, any reason to expect more from it?

*X-Box: known to randomly melt down, see early returns history, no real innovation

*Zune: who knew a simple mp3 player could crash until MSFT built one?!

*Server: too unstable for mission-critical applications

*MSN: no innovation in search capacity, has always lost money and market share, the next aol.com.

Product substitutes for Windows or Office such as Linux or OpenOffice are available for free over the internet, are faster, more stable, more secure, and consume fewer resources. Meanwhile, MSFT has brought defective products(Zune and Xbox) to a market where consumers have plenty of alternatives. Meanwhile, recent trends such as online apps, smart phones, and cloud computing could make MSFT as obsolete as IBM's old mainframes.

In this economy, I'm not going to put my money down on a bet that corporations will be lining up to pay hundreds of dollars per workstation to "upgrade" computers that already do everything they need them to do.

Mar 16 02:54 PM

[Menard:]

I am pessimistic about the future of Microsoft and there is no way I'd buy their stock. They have a lot of cash, but they'll be burning through it trying to defend their turf. Google, Linux and the bad economy over the next several years will take a heavy toll on Microsoft.

Mar 16 04:45 PM

[Whitehawk:]

The innovative growth engine in MSFT is hard to pinpoint and as such MSFT is not on par with its tech peers in performance. The cash cow is nice, and maybe that should be spun off. But if there is no growth side, then there is no growth side. I am not a buyer here, there are better places to put money.

Mar 16 05:11 PM

[Sheik Rattl...:]

On Mar 16 02:54 PM Chris B wrote:

> Sorry, but I refuse to buy a company that consistently produces inferior
> products. I know that everyone says MSFT has an unstoppable monopoly,
> but experience shows that shoddy quality eventually catches up with
> companies, and those rosy 22% five year profit growth estimates can
> easily go poof!
>
> Crappy MSFT products:
>
> *Windows (generic): inherently insecure file system, inefficient
> use of system resources, inherently unstable and crash-prone

I guess people have been buying it like crazy because they're all drunk?

> *Windows Vista: everybody hates it, enough said.

I think most people just think it's a slightly more stable but more annoying version of XP.
Haven't met anyone in person who truly hates it.

> *Windows 7: even more of a resource hog than Vista, any reason to
> expect more from it?

Explain please? All benchmarks I have seen to date indicate it is much less of a hog than Vista and slightly less of a hog than XP. Hands on experience with the beta confirms this.

>
> *X-Box: known to randomly melt down, see early returns history, no
> real innovation

I assume you're referring to the 360. In two generations MS has dominated Sony who has much more experience in this area.

Innovations in online play, digital content, multimedia features, development environment.

> *Zune: who knew a simple mp3 player could crash until MSFT built
> one?!

Pretty bad bug. Easily recovered though, unlike the occasional bricking iPod or iPhone.

> *Server: too unstable for mission-critical applications

Many corporations seem to disagree.

> *MSN: no innovation in search capacity, has always lost money and
> market share, the next aol.com.

Not a great search product. Anyone really competing with google though honestly.

> Product substitutes for Windows or Office such as Linux or OpenOffice
> are available for free over the internet, are faster, more stable,
> more secure, and consume fewer resources.

You must seriously be kidding about OpenOffice. It's good for free, but faster? more stable? Takes about 3x longer to boot up on my machine. Got any benchmarks to go with your hyperbole?

Meanwhile, MSFT has brought
> defective products(Zune and Xbox) to a market where consumers have
> plenty of alternatives. Meanwhile, recent trends such as online
> apps, smart phones, and cloud computing could make MSFT as obsolete
> as IBM's old mainframes.

First part I disagree with. Consumers are obviously happy with the 360 based on sales. And they do have alternatives as you mentioned. Clearly the Zune is less highly regarded, but I think that has more to do with look, feel, and software than a hardware bug that caused it to not work for a few hours.

>
> In this economy, I'm not going to put my money down on a bet that
> corporations will be lining up to pay hundreds of dollars per workstation
> to "upgrade" computers that already do everything they need them
> to do.

I thought you just said current versions of Windows are unusable? Why wouldn't they want to upgrade? Or is that not actually true perhaps?

Mar 16 06:10 PM

[Daniel Herkes:]

Server side = Linux


On Mar 16 08:28 AM prairiedog555 wrote:

>

> friends say that Linux and Apple are making serious inroads

Mar 16 10:02 PM

[Willten08:]

I don't know who this article's author is, and what experience or knowledge he/she has as a financial analyst or stock picker, but I sure wish him/her the best of luck in the world investing in Microsoft - a "growth", "technology giant" that has seen its share price stagnate for the last 6 years (granted, in the current market meltdown, its shares have not suffered to the same horrible extent as many other well-known brands). I agree totally with other comments that its history is devoid of real innovation, and but for its legally established monopolistic policies which assured the growth of its Windows OS and Office suite into precious cash cows regardless of quality of the products, the MS of today wouldn't exist.

Mar 17 01:54 PM