Are You Also Wrong On Microsoft?

Oct.30.13 | About: Microsoft Corporation (MSFT)

Everyone loves to hate Microsoft (NASDAQ:MSFT). The giant software company has been constantly blamed for every wrongdoing in the world, it's not innovative enough, it's an aggressive monopolist in the software industry, and most importantly it's a sleeping giant that has been napping when everyone abandoned laptops and PCs in favor of more mobile "gadgetry- like" computing.

And Microsoft has been paying a dear price for this dislike by Mr. Market. Shares of the software giant are hovering around $35, where they traded back in 2001. Let me repeat this sentence again. Shares of Microsoft are trading exactly where they traded 12 years ago, although the company has tripled its revenues and almost quadrupled its operating income since then. That's just an illustration of how much Wall Street dislikes Microsoft.

But recently, things have been starting to turn the corner for the giant software company. Shares have been gradually climbing to a six-year high, and the company just released one of its most fantastic quarterly reports ever. Specifically, Microsoft posted a 17% increase in profit, or 62 cents a share, up from 53 cents a share in the same quarter a year ago.

Not a Windows story

Wall Street used to think of Microsoft in terms of Windows, and Windows alone. This explains the crazed panic every time the PC report indicates a plunge in shipments.

But Microsoft isn't a Windows story anymore. In fact, the Windows division only accounts for $19 billion of sales a year. The highest-ranking divisions in terms of sales are the Microsoft Business Division (MBD), which accounts for roughly $25 billion in sales, and the Server and tools (S&T) division, which accounts for about $20 billion in sales.

That's why the recent 7% decline in revenues from Windows OEM should be taken in perspective.

Impressive growth

Contrary to the somewhat negative business environment for Windows, other divisions of Mr. Softy are blooming like never before. Below are the fastest growing segments:

  1. Office 365 grew an impressive 100% year-over-year. This is a very remarkable cornerstone for Microsoft since it represents a significant switch from the "old" form of Office to an online subscription based version of Office.
  2. Commercial cloud revenue jumped by 103% year-over-year. This places Microsoft back in the cloud arena, with the hope to compete sometime in the future with cloud giants like IBM (NYSE:IBM) and Amazon (NASDAQ:AMZN).
  3. Search advertising revenue grew 47% driven by an increase in revenue per search and volume. That's a sign that Bing, the company's search engine, might be diverting traffic from other rival search engines.

Shareholder friendly

Being a profit machine is one thing. But treating shareholders well is a totally different thing. As a shareholder, you must always make sure that you are treated well and that a proportionate part of the earnings goes back in your pocket.

The most direct gauge I know to measure "shareholder friendliness" is to determine the shareholder yield. This metric takes the total amount of dividends that the company has paid out and adds it to the net amount that the company has invested in share buybacks. This figure is then divided by the company's net income in order to obtain what portion of the net income returned to the pockets of shareholders. Anything above 30% is highly respectable.

When we apply the above calculation to Microsoft - we find that it's one of the most shareholder-friendly companies on the face of the earth. In the three months that ended September 30th, Mr. Softy has generated $5.244 billion in net income, of which the company used $1.9 billion to pay cash dividends and $1.98 billion (excluding share warrants) to repurchase its own shares in the open market. This brings Microsoft's shareholder yield to a staggering 74%. That's amazingly high.

The catalysts

As I mentioned earlier, although shares of Microsoft have been in the dog house for the last decade, things are finally beginning to turn the corner for the company. There are a few catalysts that might change the way investors perceive the company going forward.

  1. ValueAct, an activist hedge fund, invested $2 billion in Microsoft back in April this year. The assumption is that ValueAct's intention is to extract some of that $70 billion in cash that's sitting on the company's balance sheet - probably in the form of a large one-time dividend.
  2. There are hopes that Steve Ballmer's departure will mark a new era for Microsoft. Ballmer, who is mostly responsible for Microsoft's "lost decade," will leave at the end of 2013. Investors are hoping for a new, much more innovative leadership at the helm.
  3. Microsoft's most recent quarterly results show signs of a successful transmission to a consumer-device company. One good example of this is that the company reported robust sales figures of $400 million for its Surface RT.

My takeaway

I believe that 10 years down the road, Microsoft will be remembered as the turnaround of the century. From a sleeping Windows giant, Microsoft has transformed itself to a multi-layered device and software company, which offers a multitude of business solutions as well as entertainment products. I believe that in time, Mr. Market will learn to appreciate that. Invest accordingly.

Disclosure: I am long MSFT. 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.