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Last week, Microsoft's (NASDAQ:MSFT) stock fell more than 11% following a weak fourth quarter earnings report that included a nearly $1 billion charge related to the poor sales performance of Microsoft's Surface tablets. Is this price decline a good buying opportunity, or would investors be better served to deploy their cash elsewhere?

Good Buy

At first glance, there are reasons to believe that Microsoft is now an attractive buy. Following the steep price decline, Microsoft's shares now yield 2.93%. This yield is not only significantly higher than the general market (the S&P 500 as a whole is yielding a bit over 2% at this time), but it is also one of the highest yields offered by Microsoft's shares in the last decade. The yield is all the more compelling when one looks at Microsoft's track record for dividend increases:

Year

Quarterly Dividend

Percent Increase

2005

0.08

--

2006

0.09

12.5%

2007

0.10

11.1%

2008

0.11

10.0%

2009

0.13

18.2%

2010

0.13

0.0%

2011

0.16

23.1%

2012

0.20

25.0%

2013

0.23

15.0%

Source: Yahoo Finance.

As shown in the table above, with the exception of 2010 (which followed one of the worst recessions in U.S. history), Microsoft has increased its dividend by double-digit percentages each year. If one were to conservatively estimate that Microsoft will increase its dividend by 10% later this year, the yield on today's price would be 3.22%. For context, Microsoft's yield has been greater than 3.22% for fewer than four months, in all, out of the last decade. The rarity of this dividend yield may provide some comfort that one is buying in at a good time.

In addition to the exceptional dividend yield that Microsoft now affords, the company's balance sheet remains one of the strongest - not only for tech companies, but even when compared to the broader market. As of June 30, 2013, Microsoft had more than $77 billion in cash on its books (and long term debt of only $12.6 billion). This amounts to more than $9 per share of cash ($7.60 net of long term debt), which should afford Microsoft some time to adapt to the changing winds of the PC/device market. Notably, Microsoft is one of only four companies in the U.S. that has a credit rating of AAA. (The others are Automatic Data Processing (NASDAQ:ADP), ExxonMobil (NYSE:XOM) and Johnson & Johnson (NYSE:JNJ).)

Goodbye

But before you dash out to pick up Microsoft's lucrative yield, there are a few countervailing points to consider. First, within the last year Microsoft announced the departure of Steven Sinofsky, the head of Windows development, and Kurt DelBene, who headed-up the development of the Office suite. To fully appreciate the potential impact of these top-level changes, it's worth briefly reviewing how important Windows and Office are to Microsoft's bottom line.

For years, Microsoft has been organized around five operating segments: (1) Microsoft Business Division (i.e., the Office suite), (2) Windows and Windows Live, (3) Server and Tools, (4) Entertainment and Devices and (5) Online Services Division. These segments are not weighted equally by any means: using the most recent fiscal year's data, three heavy-weights (Microsoft Business Division, Windows and Windows Live and Server and Tools) collectively brought in 83% of Microsoft's revenue and 159% of Microsoft's operating income.

No, "159%" is not a typo: while the "big three" were cash cows, bringing in much, much more than their share of operating income, these excess profits were consumed by a cash pig called Online Services Division. Specifically, OSD lost more than $8 billion in last fiscal year, or 37% of operating income. The details are below, obtained from Microsoft's 2012 Annual Report:

Revenue

 

Operating Income

Microsoft Business Division (Office)

23,991

33%

 

Microsoft Business Division (Office)

15,719

72%

Windows and Windows Live

18,373

25%

 

Windows and Windows Live

11,460

53%

Server and Tools

18,686

25%

 

Server and Tools

7,431

34%

Entertainment and Devices

9,593

13%

 

Entertainment and Devices

364

2%

Online Services

2,867

4%

 

Online Services

(8,121)

(37%)

Corporate/Other

213

0%

 

Corporate/Other

(5,090)

(23%)

Totals

73,723

   

21,763

 

(Fiscal Year 2012)

What this means is that the replacement of the Windows and Office heads puts nearly 60% of the company's revenues - and 125% of the company's operating income - under new leadership. This may or may not work out just fine, but it is undeniably a sweeping change, and Microsoft investors are likely keeping their fingers crossed.

Second, in addition to the personnel changes that put in play nearly all of the economic value of the company, CEO Steve Ballmer has announced a massive reorganization plan that threatens to dilute the focus on Microsoft's cash cows (Windows and Office) while prioritizing underperforming products like Surface tablets and Bing. Ballmer has announced that, going forward, the company will be organized around functions that deliver devices and services, rather than product-specific divisions. Some of those who have been tapped to take on prominent leadership roles in the newly reorganized Microsoft have a track record that should give investors pause. For instance, Qi Lu has been named to lead the "Applications and Services Engineering Group," which is where Office development will likely reside. Qi Lu's prior role was head of the Online Services Division - the worst performing division in the company. Having lost $8 billion last fiscal year, Qi Lu will now be entrusted with a product line that accounts for more than 70% of the company's operating income.

Conclusion

Microsoft currently appears to be attractively valued, based on its historical valuation data. However, the wisdom of relying on historical data is questionable here: the company is undergoing a massive reorganization, and investors would have ample reason to question why the reins to so much of the company's operating income are being handed over to arguably the worst performers in the company. Relying on historical valuation data is useful only when one believes that the conditions that allowed a company to succeed in the past will continue to prevail. As Warren Buffett has noted, there are no "called strikes" in investing. If you haven't invested yet in Microsoft, it may be better to let this pitch go by.

Source: Microsoft: Good Buy Or Goodbye?