Microsoft's Got Talent

When I think of Microsoft (MSFT) stock, images of Susan Boyle in "Britain’s Got Talent" come to mind. The Scottish woman appeared -- middle aged, awkwardly dressed, unsure of herself, unattractive by conventional (stereotypical) standards -- and expectations of her singing were in line with her appearance. As long as she did not fall off the stage, the audience would have concluded that her performance was a success.

If Susan Boyle was a stock, I’d call her a deep value stock with very low expectations, and thus a great margin of safety, selling at a discount to its fair value.

Then she opened her mouth, and to everyone’s shock, this duckling had a beautiful swan of a voice. She became an overnight sensation. The video of her performance was YouTubed more than President Obama’s inauguration.

Then here comes Microsoft. The company’s name doesn’t have the luster it once had. It's seen as middle-aged, overweight and slow, and it is believed by many that creativity retired with Bill Gates.

The sentiment is so horrible that there is almost universal expectation that it will not come up with another good product, ever. Kodak (EK) and Polaroid are now used to describe Microsoft’s “bright” future, and Apple (AAPL) and Google (GOOG) are the ones that will retire it there.

But the ugly duckling is about to sing, and it will be a Susan Boyle-like performance.

Vista's flop will lead to Windows success
Microsoft is releasing Windows 7 sometime in late 2009 or early 2010. It's last operating system, Vista was a flop. Consumers did not care for the product and corporations did not upgrade.

Of course failure is a relative term when it comes to Microsoft. At its release, Vista sales were double that of XP, the previous version. Vista still commands almost 24% of market share, second only to XP’s 60% plus.

Windows 7 is not just another new release. It is really Windows Vista 2.0, or Vista-fixed, if you like. Microsoft took Vista’s kernel – the core of the operating system -- fixed it, made it faster, improved the interface and added new features, Voila, you’ve got a new multibillion dollar product.

Many corporations did not upgrade to Vista: they stayed with XP. This is now eight years old, a dinosaur in software years. Microsoft will eventually discontinue support and updates for XP. Unless all hackers “pinky swear” (my 8-year-old son’s favorite phrase) that they’ll not try to figure out a way to hack into the 400 million computers that run XP worldwide, a computer running could be left exposed to new security attacks.

Corporations will not likely take hackers' “pinky swears” so they’ll have no choice but to upgrade to Windows 7. Also, this time they won’t have to do the usual thing and wait for Service Pack 2 -- the inevitable set of bug fixes to the original product. Vista’s Service Pack 2 is already out, and in many ways Windows 7 is Service Pack 3. Expectations created by Vista for Windows 7 are incredibly low for Microsoft, but 7’s success is likely to be very high.

Other reasons to go Bing
There's more: Aside from Windows 7, there is plenty of promise in other products that are not built into Microsoft's stock. Bing, a new, improved search engine, is just out and the presentation I’ve seen of it is very impressive. Office 2010 will bring a subscription-based office onto the Web which may fix a longstanding consumer piracy issue. (I personally don’t know a single person who actually bought a copy of Office for home use. Maybe I need new friends, but people just don’t want to pay $300-400 for something that we consider our birthright. )

With Office Live, Microsoft will charge an annual fee, and you’ll get a Web product that has the same look and feel of the Office you are used to using at work.

This ugly duckling is not hanging by a thread. Microsoft still has Windows, server products and Office, holds a leading position in gaming, generates billions of dollars of free cash flow, has $23 billion of cash and its debt will likely be trading at lower yields than Treasury’s very soon.

But the best part, there is nothing positive priced into this stock, which trades at about 10 times free cash flow. It is incredibly cheap. Buying it now is like a talent agent signing Susan Boyle as a client the day before she went on stage.

P.S. Though I’ve written this article last week, before Susan Boyle lost on Britain’s Got Talent, her loss did not make the point of the article any less valid. In fact, I spent several hours this week watching Britain’s Got Talent on YouTube with my wife and kids. What an incredible show. Susan Boyle did not win, but did not lose either, she’ll will likely become a big star – she has a wonderful voice. I’d buy her CD and go to her concert in a heartbeat.

Comments

[Jayclutch:]

Great article. You make a very good point in mentioning that its core business is still very strong. Although Microsoft has been lagging in some areas (zune), it is still a strong company with strong product offerings. I'm excited to see what its new motion sensored controller (similar to that of the wii) does for it's gaming division, as well as what the initial reaction to its new OS Windows 7 will be like.

Microsoft is far from being a dinosaur and is far from dead...

Jun 02 11:09 AM

[jayminho:]

your fundamental analysys is 100% correct, I do share the same expectations and opinion as yours, and honestly, I ve been asking myself since early 2008 (when msft was at 29.xx trying to break 30) - "why so cheap?" - then, came the yahoo insane shit, the price dropped, and now, even cheaper.
yep, maybe its time to get into mr soft.
what bugs me, is the fact that, they trade sidelines, for years.
they just dont move. its amazing.
i regret selling my sunw(java) position. and so many other tech stocks.
well, whatever, praise msft.

Jun 02 11:25 AM

[goodwill_p:]

I just want to mention that Windows Vista core is based on Windows XP (that is why many people called VIsta a sugarcoated XP, but slower), so, is Windows 7 just another Windows XP at the end? VIsta was supposed to be a new engine with breakthrough capabilities like search, file indexing, and communications (Avalon, Indigo, etc), but many of those features were removed due continuous delays and they just built on top of XP.

Jun 02 12:51 PM

[Tom B:]

Worthless article. Plenty of people will buy Win7, to be sure, because it will come on PC's. And it is said to bring Windows back to a generally "Win XP" level of performance ( a pretty low bar, but refreshing, no doubt, after Vista). But let's be totally clear here: Win 7 is still a dodo bird, doomed to extinction. SOMEDAY, MSFT will have to make the switch to UNIX. Apple did it 9 years ago. LINUX has been UNIX since its inception. I don't even see this obvious reality on MSFT's roadmap. Their entire business model is to expect Enterprise IT drones (their core base of support) to remain stupid and change-resistant for another 20 years. Guess what-- the guys that grew up on DOS are all retiring. Any kid who grew up tinkering with adult, modern OS's will be unimpressed with the idea of dealing with Windows Registry; poor performance; and insolvable security holes.

And Bing seems unlikely to ad to the top line. A less capable knock of of Google with hot air balloons? Please!

Jun 02 10:44 PM

[Martiandreams:]

I was more thinking of Monty Python: Gooood night, bing bing bing bing.

Where is Altavista gone? Lycos? Microsoft can buy these brands virtually for free.

"Expectations created by Vista for Windows 7 are incredibly low for Microsoft, but 7’s success is likely to be very high."

In what way is Windows7 better than XP SP2? This is the question Microsoft was unable to answer for VISTA. Now the security support argument is an auto-dafe. I expect a company to support a product for its customers forever as long as millions are still using the software in a productive environment and there are unfixed security bugs. In fact Microsoft should become liable for the security bugs which are exploited by malware.

Jun 08 09:41 AM