In light of Microsoft's (NASDAQ:MSFT) most recent earnings report in which investors gave a collective thumbs down, I started to review the operating model to see where and how Microsoft might return to favor with investors.
Clearly, investors are skeptical of the current model and a superficial organizational realignment. What Microsoft needs is a blockbuster re-imagination of its business and, in my view, that means being the owner of content to complement their hardware (Xbox and Surface tablet) and ecosystem.
The competitive landscape is becoming quite blurred among the technology heavy weights: search, software, hardware, cloud services, content creation and distribution. Amazon (NASDAQ:AMZN), Google (NASDAQ:GOOG), and Apple (NASDAQ:AAPL) are all converging on users to bring them on to their digital platforms.
Platforms, ironically, make switching costs higher for consumers. Higher switching costs, of course, reduce churn and make consumers more apt to stick around and use the plethora of services available through each respective ecosystem.
Own The Living Room
Microsoft derives a lion share of its revenue and profits from its Windows operating system and office suite of software. In my view, Microsoft could also benefit from another intangible good: content.
Because Microsoft already has a significant installed base of Xbox devices and is growing its sales on its Surface tablet, a clear, moat-creating competitive advantage would be to own the content which to exclusively distribute through those devices.
With that in mind, in my view, both Activision Blizzard (NASDAQ:ATVI) and Netflix (NASDAQ:NFLX) could both be interesting assets to envision under the Microsoft camp. Both those businesses would certainly help Microsoft 'own the living room' with the Xbox and the Surface being the center piece. Specifically, ATVI and Netflix would give Microsoft exclusive content to deliver through its Xbox platform, and provide another high margin, sticky revenue stream from their subscription business models.
To give an idea about the power of a content ownership and distribution model, Japanese telecommunications operator Softbank recently offered to pay $8.5 billion for Universal Music Group, a wholly-owned subsidiary of Vivendi (OTCPK:VIVHY). At that price, a significant purchase price premium appears to be baked in.
What would Microsoft look like if it owned ATVI, UMG and Netflix? It would have a powerful and complementary set of assets, all of which would instantly create a content rich ecosystem, and a competitive advantage over its tech platform competitors Apple, Google and Amazon.
Owning the content would allow Microsoft to exclude its competitors from using it if it so chose. For example, it could exclude Sony (NYSE:SNE) from ATVI's popular Call of Duty franchise. Alternatively, it could extract a premium royalty rate by licensing the content to the Japanese video game console maker. The same competitive positioning would apply to exclusive film and music content with respect to other ecosystem competitors.
With $77 billion cash and equivalents on the books, if all ATVI ($12 billion enterprise value), UMG ($8.5 billion based on Softbank offer) and Netflix ($14.8 billion enterprise value) were all up for sale, Microsoft could acquire each and still have $42 billion in cash. However, it would be adding about $15 billion of cash generative sales to the Microsoft's top line, a quick 20% bump, with multiple opportunities to increase sales across the Microsoft ecosystem.
Of course, these ideas are just musings regarding Microsoft's strategic positioning and how it could return to favor with investors by offering a clear strategy to win the day in the technology platform wars.
Clearly, acquiring all three of those businesses is a hypothetical, but they certainly seem to all fit the future model for tech companies, where platforms made up of content, business apps and cloud services create ecosystems with high switching costs for consumers, thereby allowing for key competitive differentiation.
Owning proprietary and exclusive content would be one way to create a moat against Google, Amazon and Apple.
Disclosure: I am long OTCPK:VIVHY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.