On August 23, 2013, Microsoft (MSFT) issued a press release that Steve Ballmer, CEO, would retire from his post within the next 12 months. Steve Ballmer, Bill Gates' right-hand man, has served as CEO since January 2000. Within the immediate hours following Ballmer's announcement, Microsoft stock had gapped up to $35.17, before closing out the August 23 date at $34.75 upon heavy volume of 223.3 million shares trading hands. After the smoke cleared, Microsoft shares had put up a $2.36, or 7.3%, gain on the session. Calculated out further, the Ballmer decision to step down added an immediate $20 billion in market capitalization value to Microsoft Corporation. If capitalized at 7%, the present value of Ballmer's resignation is valued at $285 billion in additional future net income. Wall Street, as always, has gotten far ahead of itself. Microsoft is still a strong sell. The structural problems at Redmond are now well beyond the management capabilities of one man.
I am a Mac. And I am a PC.
On October 26, 1999, both Intel (INTC) and Microsoft were first included within the Dow Jones Industrial Average as component stocks. In retrospect, this event clearly marked the apex of the PC revolution. At the time, Microsoft stock traded for a split adjusted $34.26 per share, or $172 billion in market capitalization. Again, Microsoft stock currently trades near $35, which calculates out further to $285 billion in market capitalization. Microsoft now operates with 8.3 billion shares outstanding, which is a significant increase above the 5.1 billion shares of common stock reported in 1999. In effect, Microsoft stock has done nothing over the course of the past fourteen years, besides return larger proportions of profits back to investors as dividends. With Ballmer at the helm, Microsoft has offered negative real returns. Obviously, value investors would have fared better putting money to work within consumer staples and commodity plays, such as Coca Cola (KO), Altria (MO), and Exxon Mobil (XOM). Going forward, these stocks will continue to outperform Microsoft.
Apple's Get a Mac campaign still defines the consumer electronics marketplace. This series of advertisements personified Apple as a charismatic, yet eager to please hipster. Juxtaposed against Apple, actor John Hodgman stood in for Microsoft as a company man in a tweed suit, who demanded help to stay out of his own way. Over the past decade, Apple has emerged as the alpha technology business after bringing the revolutionary iPod, iPhone, and iPad platforms to market. To date, only Google Android has emerged as a formidable rival to the popular Apple iOS operating system. Meanwhile, Microsoft and Ballmer have been literally caught with their pants down. After Windows, the X-Box console remains Microsoft's only real game changing hit. Unfortunately for Redmond, an X-Box video game is a dead end, in terms of driving traffic towards a Windows ecosystem of smart phones, personal computers, and tablets.
On October 9, 2012, Microsoft released its 2012 annual report. According to Steve Ballmer, Microsoft was then prepared to leverage the "big opportunity" of establishing a Windows 8 operating system to serve as the primary backbone for personal computer, tablet, smart phone, and cloud computing. At the time, Microsoft had averaged meager 2% net income growth through the course of the four prior years. Taken together, the language and statistics of the report implied that Microsoft would aggressively target the smart phone and tablet markets as growth opportunities. On July 30, 2013, Microsoft filed its 2013 annual report with the Securities and Exchange Commission. Nearly one year after Ballmer's bold declaration, Microsoft posted $77.8 billion in revenue, which was a 6% increase above the prior year. Upon further analyses, however, Ballmer's pet Windows 8 project was a failure.
Windows 8 Fail
Microsoft has historically classified its business according to Windows Division, Microsoft Business, Server and Tools, Entertainment and Devices, and Online Services groupings. These divisions may be somewhat misleading, due to technical overlap between Windows Division and Microsoft Business. The Microsoft Business Division does include Office. The Office software set is an umbrella classification above Office 365, SharePoint, Exchange, and Lync. Taken together, these programs have generally accounted for more than 90% of Microsoft Business Revenue. Alternatively, Microsoft has defined its Windows Division as a unit covering operating systems and software for computing devices, tablets, and smart phones. Windows Division sells product to consumers, businesses, and original equipment makers (OEMs), such as Hewlett Packard (HPQ) and Dell (DELL). Sales to OEMs have accounted for roughly 65% of Windows Division revenue. In all, Microsoft Business and Windows divisions combined to generate $44 billion of the company's $77.8 billion 2013 in total net sales.
Beneath the nominal figures, however, Windows 8 has failed to trigger real growth, while the personal computer market continued to deteriorate. A May 2013 report out of research firm Net Market Share indicated that Windows 8 sales lagged far behind the disappointing Vista at similar chronological points within both product life cycles. Still, Windows software operated more than 90% of all desktop machines through the first two calendar quarters of 2013. All recent data highlighted a trend of consumers maintaining Windows 7, Windows XP, and Vista machines, instead of opting to upgrade into Windows 8. The original equipment manufacturers, however, may still purchase Windows 8 licenses, in order to stay current. In effect, Microsoft has degenerated into a utility, where it is the only game in town. Unfortunately for Microsoft, its PC residents have been packing their bags for greener pastures. Microsoft cheerleaders who celebrated the Steve Ballmer resignation announcement should calculate that it is too late to turn around this Titanic and drive it towards real growth.
On July 10, 2013, research firm Gartner released its PC shipment estimates for the second quarter of 2013. Gartner defined desktops, laptops, and notebooks as personal computers. Gartner identified tablets, however, as a separate group. According to Gartner, Q2 2013 global PC shipments totaled 76 million units, which was a 10.9% decline relative to the year-over-year period. All top-five original equipment makers lost sales on the global market during this time frame. Additional Gartner data and reports have broken down statistics according to Middle East and Africa, Western Europe, and United States geographic regions. Middle East and Africa, and Western Europe PC unit sales experienced respective 16.8% and 19.8% percent declines during the Q2 2012 to Q2 2013 time frame. Alternatively, the PC unit sales in the United States posted a relatively minor 1.4% decline during this second quarter. Shipments of Apple Mcintosh Computers also fell in the United States by 4.3% -- to 1.7 million Q2 2013 unit sales.
Mikako Kitagawa, principal analyst at Gartner, went on to deliver a classic "between a rock and a hard place" statement to Microsoft shareholders. According to Kitagawa, placing blame upon Windows 8 for the decline in PC sales was "unfounded." Kitagawa said that the disappointing Windows 8 launch "does not explain the sustained decline in PC shipments, nor does it explain Apple's [deteriorating] market performance." Identifying a specific culprit for the ongoing collapse of the PC business model may be irrelevant at this junction in time. In any event, the size of the PC market has shrunk for five consecutive quarters. Meanwhile, recent comScore and International Data Corporation surveys have indicated that Microsoft Windows is a relative non-factor within the smart phone and tablet markets. On November 12, 2012, Microsoft's Steven Sinofsky abruptly resigned amidst these news events. Sinofsky had reported to work at Redmond as the President of Windows Division for the past 23 years.
The Bottom Line
The buck has finally stopped at the desk of Steve Ballmer. The shadow of Bill Gates, however, still commands Microsoft. Bill Gates remains the largest shareholder at Microsoft, which translates into implicit power to head a de facto search committee to name the next CEO. Investors must recognize that Gates' presence is likely to perpetuate a workman-like culture at Microsoft. This utilitarian approach to doing business may work well within banking, consumer staples, manufacturing, and of course, utility circles. Resistance to change, however, effectively spells death for technology enterprises. According to Moore's Law, the number of transistors that can fit upon one integrated circuit should double every two years. Ironically, both Intel and Microsoft miscalculated the consumption shift away from bulky personal computers, and towards portable smart phones and tablets.
Microsoft stock now trades for 13.5 times trailing earnings. On paper, this valuation may appear cheap. In reality, Microsoft should be evaluated as a zero-growth business that regularly offers up a 2% income yield. As such, Microsoft remains a relatively expensive investment. Be advised that The Federal Deposit Insurance Corporation (FDIC) guarantees $250,000 worth of cash savings per depositor, per institution. The inevitable rise in interest rates off the 0% floor would drain capital out of equity markets and Microsoft stock. Until then, value investors may opt to buy and hold Altria.
Going forward, Wall Street will quickly discover that Steve Ballmer's resignation is worth zero, let alone an immediate $20 billion infusion of market capitalization at Microsoft. Microsoft is a strong sell.