A Microsoft Spin-Off May Be In The Cards Regardless Of CEO Pick

Nov.12.13 | About: Microsoft Corporation (MSFT)

A series of what can only be thought of as trial balloons from sources close to Microsoft (NASDAQ:MSFT) front runner Stephen Elop have recently appeared in both tech and financial news outlets.

The proposition? Simply, that if Mr. Elop becomes Microsoft's new CEO, he would ...

... consider killing off money-losing operations such as its Bing search engine and its Xbox video game console. Elop would also try to sharpen the company's focus and would make a cross-platform Microsoft Office that works on the iPad one of his top priorities.

Let me preface this by saying that I have no idea who's grinding this particular axe, be it a pro-Elop or anti-Elop faction, attaché or partisan. If Mr. Elop was, as his critics suggest, a trojan horse for Microsoft during his brief but turbulent tenure as Nokia's CEO, then he's certainly earned his spurs vis-a-vis the folks in Redmond, regardless of whether they're singing his praises in Keilaniemi.

As for the strenuous denials of Microsoft's PR department, frankly, I'd be more concerned as a Microsoft investor if the prospective new CEO company wasn't considering in and all available measures in order to maximize shareholder value. The general preference amongst investors for transformational leaders, as opposed to the situational or transactional variety, is more often than not a product of survivorship bias: For every Steve Jobs or Lee Iococca out there, there's a dozen Rob Johnsons. (Besides, there's the question of scale: How "transformational" can you really be when you're running the world's 6th largest tech company?)

But regardless of who is ultimately picked as the new Crown Prince of Redmond, one thing is certain: "The times, they are a-changin'."

Show Me The Money

For starters, the knives are out for Bill Gates.

ValueAct's insurgent campaign in favor of new blood and changing Microsoft's "capital allocation policies" (read: writing investors a series of very big checks) may have failed to stop Gates' re-election, but the genie is out of the bottle. The news headlines may be filled with tales of Apple's overseas war chest, but Microsoft's slush fund is acquiring a hedge fund bait, Scrooge McDuck-like quality all its own, exceeding the annual GDP of Panama, Costa Rica, Yemen, El Salvador and Bolivia.

MSFT Cash and ST Investments (Annual) Chart

MSFT Cash and ST Investments (Annual) data by YCharts

Empire Building

Unlike Apple, Microsoft has a history of empire building through strategic, multi-billion dollar acquisitions. The results have been less than spectacular. Microsoft investors still have a bad taste in their mouths over the company's $6.2 billion acquisition of the online advertising company aQuantative which was supposed to take the fight to rival Google (NASDAQ:GOOG) by allowing Microsoft to serve up millions of ads all over the web.

From Microsoft's original press release:

Today we take a significant step forward in our ability to capture share of the $40 billion online ad opportunity and the larger $600 billion ad market, which is rapidly shifting to the world of online and IP-served platforms, including TV and gaming.

The aQuantative debacle sprang from the same root cause as Hewlett-Packard's Autonomy woes: A cash-rich company tries to steal a march on the competition by buying up a "hot" new property that has nothing to do with the parent company's core competency. Either no one at Redmond bothered to ask how well aQuantative would mesh with Microsoft's existing programs and services, or they were overruled.

Warren Buffett emphasizes the lust for "empire building" amongst ultra-alpha CEOs. He would know. I have no doubt that Steve Ballmer, Leo Apotheker and Gerald Levin believed that they were acting in the grand world building tradition of Alexander the Great. I'd argue, however, that the institutional imperative that drove those bad deals had less in common with a young Mediterranean conquering the world at 30 and more to do with a search for the Fountain of Youth.

The infamous merger of AOL and Time Warner is a case-in-point: Time Warner executives were afraid that their sprawling media empire would be outflanked by the Internet. AOL's (NYSE:AOL) then-COO Bob Pittman played those fears like a fiddle by offering Time Warner a turn-key solution to avoid extinction:

All you need to do is put a catalyst to (Time Warner), and in a short period, you can alter the growth rate. The growth rate will be like an Internet company." (emphasis mine)

Ah, to be young again! Unfortunately, youth isn't like cooties. It doesn't rub off on you. A rich old company can't become a young company through acquisition any more than a rich old man can become a young man by dating a woman half his age.

Back To The Rebellion

Fast-forward to Now: If Microsoft's is forced to write-off another multi-billion dollar acquisition in the near-term future, or another major product fails to gain mass acceptance in 2014, activists' calls for either increased buybacks or a special dividend (or both) will be shrill, indeed. Nor is it a foregone conclusion that Redmond's insiders still possess the votes necessary to stop the barbarians at the gate: Bill Gates' voting power is currently eroding at the rate of 20 million shares per quarter due to the automatic sales that fund his Foundation, and neither Steve Ballmer's position, years of influence, or voting power were sufficient to keep him in the driver's seat. Besides, if Redmond's new CEO's only plan is to execute Ballmer's vision of "One Microsoft", what was the point of removing him as CEO?

More to the point, what's to stop David Einhorn or Carl Icahn from joining forces with ValueAct or Blackrock (NYSE:BLK) for that matter? Though BlackRock currently owns just 2.51% of the company, its current position as the world's largest asset manager (it's the largest shareholder in one of every five U.S. companies and owns a 5% or greater interest in more than two-fifths of publicly-traded US companies) gives BlackRock's roughly 1,600 portfolio managers influence over matters of corporate governance disproportionate to its share bloc, especially during proxy season.


Whoever gets the CEO nod will ultimately have to make it rain for Microsoft investors, if for no other reason than the fact that 5% of the company's stock is already in disgruntled hands and Microsoft's untapped war chest is a hedge fund's wet dream.

That leaves the next Crown Prince of Microsoft with few sure-fire options for getting the stock up. While a breakout product is always possible, it's far from guaranteed. Borrowing more money is another option, but increasing the company's debt load would hardly be the best way to make a first impression. Repatriating some of the company's overseas cash hoard would be patriotic, but about as pleasant as a root canal. Depending on the circumstances, a spin-off could be read by the market either as an admission of weakness or a sign that "The New Microsoft" is committed to focusing on core competencies.

However it ultimately plays out, the result is likely to be a net positive for Microsoft investors. After all, in the words one of America's most prestigious angel investors, "a little rebellion, now and then, is a good thing."

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.