Microsoft's 2 Big Problems

Oct. 3.13 | About: Microsoft Corporation (MSFT)

Microsoft (NASDAQ:MSFT), a terribly successful company, has two big problems. The first is that it is a "franchise." That is, it has been a gigantic success that has, through the creation of a huge networked platform, evolved into a monopoly position with little or nowhere to go.

One has to go back nine years before one can find a return on shareholder's equity of less than 25 percent. And, before that the returns were in excess of 15 percent. The peak return on shareholder's equity over the last nine years was almost 50 percent.

In addition, Microsoft's market share still remains in the stratosphere.

Microsoft can certainly be said to possess a sustainable competitive advantage. Others could argue that it possesses an even stronger market position … maybe even a monopoly.

Still, Microsoft, the major player in the commercial and corporate world, wants to be a player in the consumer world … and this is where the greatest disappointments have come. It seems to want to be all things to all people.

This is not producing a lot of excitement in the investment community. Evidence of this comes from Mohamed El-Erian, the CEO and Co-CIO of PIMCO who states in the September 30 issue of Barron's that PIMCO is "focusing on companies that have very solid balance sheets and are generating a ton of cash, because they are giving that back to the equity investors. So, dividend-paying companies likely to increase their share buybacks are attractive. An example of that is Microsoft."

What El-Erian is talking about are companies that have "made it," companies that have major market shares who believe that barriers to entry into their marketplace are sufficient so that they do not live in the fear of competitors. They generate "tons of cash" and they have enough that they can "play around" in areas that intrigue them, but they tend to be dabblers in these places and they really don't waste a lot of cash in their minor distractions.

And, this is problem one. The second problem really results from problem one … the success of the company.

The second problem has to do with the presence of Bill Gates. Mr. Gates is legend and myth! And, given the results of the company, no one can really debate this lofty position. But, the presence of Mr. Gates is overwhelming to the mortals that have to run Microsoft.

This is not an unusual problem in situations like this. People, like Bill Gates can be very proud of what they have done … and rightly so. But, we learn from history that sometimes, people like Mr. Gates find it hard to let go of the gem that they have created.

Mr. Gates is doing good elsewhere and he deserves lots of credit for this other work. But, focusing on these other things diverts the intensity with which he should be leading Microsoft.

Steve Ballmer has had a long association with Mr. Gates. He has always done what Mr. Gates has wanted him to do … at least in major things … things apparent to the investing community. Mr. Ballmer's tenure as the CEO of Microsoft can really be seen as just an extension of Mr. Gates. This may not be entirely fair to Mr. Ballmer, but at the present time, it seems as a pretty valid assessment.

The "control" Mr. Gates exercises over the Microsoft organization is apparent in the fact that Mr. Gates is one of the four people that are now serving on the search committee looking for a successor to Mr. Ballmer. Mr. Gates, one can imagine, is only going to dominate this search process.

Major shareholders are getting restless. "The search is being watched closely by leading shareholders to ensure the next chief executive is 'truly new', one of Microsoft's 10 biggest investors said." But, Mr. Gates seems to be controlling the situation.

Microsoft can be an adequate investment going forward … especially in the current economic and financial environment … for the reasons given by Mr. El-Erian. As such, there is little incentive for Microsoft to do much more than just live off of its "sustainable competitive advantage" for as long as it can.

And, if Mr. Gates continues to dominate Microsoft as he always has, then it is hard to expect that Microsoft will do much more than it has already done. After all, this is what hubris is all about.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.