On October 26, 1999, running partners Microsoft (MSFT) and Intel (INTC) were added to The Dow Jones Industrial Average as component stocks. In retrospect, that event established the pinnacle of the personal computer revolution, as part of the aggregate technology economy. At the time, Microsoft and Intel shares traded for a split-adjusted $34.26 and $27.53, respectively. In terms of market capitalization, Microsoft ($471.9 billion) and Intel ($237.5 billion) were valued at a combined and approximate $710 billion. On September 17, 2013, Microsoft and Intel shares closed out the trading session at respective $32.80 and $23.39 price points. Again, in terms of market capitalization, this performance calculates out to roughly $275 billion and $115 billion valuations for Microsoft and Intel, respectively.
Fourteen years of aggressive stock buyback and dividend payment programs have literally slashed the size of the Microsoft - Intel PC twin business engine in half. The moves to redistribute larger portions of capital, however, have not resulted in real growth for shareholders at either company. The strength of the personal computer business has quickly deteriorated over the past decade. In response, Microsoft and Intel are both circling the wagons to defend their bread and butter businesses, while also throwing money at mobile research and development and acquisitions. Ironically, Moore's Law has emerged to drive the consumer market away from the personal computer and towards mobile. Microsoft and Intel are dead money and should be sold, in favor of an even more conservative stock, such as Altria (MO).
Moore's Law and the Personal Computer
In a 1965 paper, Gordon Moore, Founder of Intel, theorized that the number of transistors that could fit upon one particular integrated circuit would double every two years. In laymen's terms, consumer electronics would become significantly more powerful, yet smaller through time. According to Moore's Law, a technological revolution may take place every other year. Over the past decade, the personal computer revolution has ceded authority to mobile, which would include both smartphones and tablets. On February 10, 2011, Microsoft and Nokia (NOK) announced plans to partner up and build out a global ecosystem. The following year, in 2012, Intel finally helped roll out the first phones featuring its mobile chip technology. This Intel Inside smart phone line up has grown to include the Acer Liquid C1, Motorola RAZR I, and Safaricom Yolo handsets sold in emerging markets including Kenya, Thailand, and Mexico.
As proverbial fast followers, both Intel and Microsoft are attempting to muscle their way into the mobile sphere, while the personal computer market has all but collapsed. Most likely, executives at both firms would define their financial results as lagging indicators. The lion's share of sales at Microsoft and Intel are to original equipment manufacturers (OEMs), instead of end consumers. The recent Windows 8 launch literally forced computer hardware companies to purchase software licenses and Intel processors to stay current. Weak consumer demand will initially appear as heavily discounted computers at Best Buy (BBY), before working itself through the PC supply chain as inventory write downs and earnings estimate shortfalls at Hewlett Packard (HPQ), Dell (DELL), Intel, and Microsoft.
On July 10, 2013, research firm Gartner released a report summarizing global PC shipments through the second calendar quarter of 2013. According to Gartner, global PC shipments contracted by 10.9% through Q2 2013. Gartner was to then follow this report up with news that the consumer PC market in Western Europe collapsed by 25.8% during the same time frame. Meike Escherich, Gartner principal research analyst, has already forecast that Holiday Season Windows 8.1 and Intel Haswell machines "will not fully compensate for the ongoing PC decline."
The Mobile Market
On September 3, 2013, Microsoft issued a statement that it would be purchasing Nokia's handset and services business for $7.2 billion, while continuing to license patent and mapping technologies. The following week, on September 10, 2013, Intel unveiled its Bay Trail platform at its Developer Forum in San Francisco. Bay Trail emerged as the over arching name used to identify Intel's System-on-a-Chip (SoC) line technically listed as the Atom Z3000. Atom was established as a larger umbrella category above Intel's mobile semiconductors. Beneath the Atom, Bay Trail now includes a subset of chips designed to power what Intel refers to as "two-in-one" machines that fuse traditional tablet and laptop capabilities together. The Microsoft Surface tablet does run Office and folds out to include a working keyboard. Technology enthusiasts have speculated that several Windows 8.1 / Bay Trail tablets will retail for between $250 and $450 heading into this Holiday Season.
At best, the Windows operating will further solidify itself as a third-wheel alternative to the dominant Google (GOOG) Android - Apple (AAPL) iOS duopoly through calendar Q4 2013. Microsoft and Intel, as always carry the cash, but lack the cache, to overtake Apple and Google on Main Street. On September 6, 2013, research firm comScore released a report that summarized July 2013 U.S. smart phone subscriber market share. The comScore information actually presented averages of data taken for the calendar quarter that spanned between May 2013 and July 2013. During this time frame, the Google Android - Apple iOS duopoly operated 92.2% of U.S. smart phone shipments. At the bottom of the heap, Windows operating a meager 3% of the Q2 2013 smart phone market. Interestingly, the Android and iOS platforms have gained in strength throughout the year, despite lofty rhetoric out of BlackBerry and Microsoft camps.
To add further insult to injury, Wayne Williams and Beta News recently ripped Microsoft Surface tablet performance as "pathetic." An August report out of International Data Corporation (IDC) also confirmed the presence of another winner-take-all market in tablets. IDC estimated that Windows operating system tablets accounted for 2 million Q2 2013 shipments, for a mere 4.5% share of the market. For the sake of comparison, Apple iOS and Google Android operating systems combined to power 42.8 million tablet shipments during this latest second calendar quarter. Be advised that Apple reported a 14% decline in iPad tablet sales during this same time frame. Apple will launch iPad tablet upgrades prior to the Holiday Season. According to Tom Mainelli, IDC Research Director of Tablets, "A new iPad launch always piques consumer interest in the tablet category and traditionally that has helped both Apple and its competitors." Bears, however, may rationalize that tablet market growth has already peaked, at the worst possible time for both Microsoft and Intel.
The Bottom Line
On top of Moore's Law, all efforts at Microsoft and Intel to generate shareholder wealth will be sabotaged by the law of large numbers. Several billions of dollars in mobile revenue will barely move the needle at these two companies that have averaged more than a combined $46 billion in cash flow from operations over the past three years. Unfortunately for shareholders, the personal computer has remained the focal point of this cash machine. Intel's PC Client Group typically accounts for two-thirds of total net revenue at the company each year. Alternatively, Microsoft Windows and Business operating segments combined for $44 billion of the $78 billion in 2013 revenue collected at the company. Microsoft Business is largely made up of Office software sales. 2013 results at Microsoft did include one $900 million charge related to Surface tablet inventory.
Microsoft bundles its Windows Phone results within its Entertainment and Services division that also includes the popular Xbox gaming console. Microsoft Entertainment and Services posted a mere $848 million in 2013 operating profits off of $10.1 billion in revenue. The Nokia Devices and Services division has already tallied $100 million in operating losses through the first half of this year. Alternatively, Intel's Other Architecture operating segment overlaying mobile chip technology has generated less than 10% of revenue at this company over the past three years.
As an adjunct to Moore's Law, the technology economy is highly susceptible to deflation, or outright busts, when products shift through the business cycle. Again, the aggressive entry of fast followers Microsoft and Intel may signal that the wireless industry is rapidly entering the maturation stage, before slogging through the inevitable decline. As such, conservative investors, who wish to leverage strong cash flow and dividends for growth, should consider rotating capital out of a Wireless Industrial Complex that would include Apple, Qualcomm (QCOM), BlackBerry (BBRY), Microsoft, and Intel, and into a consumer staples stock like Altria. Unlike outdated technology products, tobacco prices generally outpace the rate of inflation over time. Tobacco is relatively price inelastic, as consumers are willing to buy at practically any price. Between October 26, 1999 and September 17, 2013, Altria stock climbed from a split-adjusted $2.69 to $35.36 per share, while Intel and Microsoft investors have been relegated to accept negative real returns. In addition to Altria's long-term price appreciation, the stock now pays out a healthy 5.5% dividend yield.