I have written about the future of Microsoft (NASDAQ:MSFT) for two days in a row now…"The Microsoft Future" and "I Don't Know How to Answer Your Question: Microsoft's Steve Ballmer"…and I have been really surprised by some of the comments.
I have been the President and CEO of two publicly traded companies and the Executive Vice President and CFO at another. It was always my assumption that the primary objective of the management of a company, especially that of the president and CEO, was to maximize shareholder value…maximize the share price of the company's stock.
I look at a chart showing the price of a share of Microsoft stock since 1986 and I see the trajectory of the stock going up at almost a 45 degree angle from 1986 until around 2000 when the stock price peaks out. There is a correction in the first half of 2000 and then, after the correction, and in a chart that covers twenty-seven years, the price of the stock is almost a flat line, fluctuating within a very narrow range, until the present time.
The S&P 500 stock index hit a peak of around 1,530 in March 2000 and September 2000, before a substantial decline took place. Note, that the latter number is after the price of Microsoft made its correction. The stock index dropped to a trough of around 800 before returning to a level in excess of 1,500 but below 1,600 in 2008. The index fell once again down in the 700 range before returning to where it is today.
My point is that from January 1, 2000 when Ballmer took over at Microsoft the stock market suffered two sizeable downturns and two substantial recoveries while, during the same time period, Microsoft stock traded within a relatively narrow range, moving very little with the market.
From the data presented so far, two conclusions can be drawn from the Microsoft stock performance. First, Microsoft has a low Beta. Value Line estimates the Microsoft Beta to be 0.85, significantly below one.
Second, one can argue that the Microsoft Alpha is very low, given that the stock price has basically done nothing over the past thirteen years.
How did a company that produced "information goods" create Alpha? The standard economic description of a company that produced an information good explained that this company "earned" its Alpha by spending a lot of money "up front" to create its platform. The company could then achieve scale by building a "network" around this platform that allowed it to sustain its competitive advantage. Since information goods could scale at close to zero marginal cost as it expanded it could operate at huge margins. The huge margins that the company operated at could then be used to finance further growth of the company without having to issue any debt…retained earnings became the engine of expansion..
The prime example of a company that produced an information good is Microsoft.
Microsoft was a "cash machine". Its cash flow per share was huge…and it continued to increase every year under Mr. Ballmer's leadership. In 2000 cash flow per share was $0.99. In 2013, this number grew to $3.15. The Microsoft "machine' was a true cash generator.
Because of this cash flow, Microsoft was never short on working capital and could use these funds as a source of investment capital to do just about whatever it wanted to do. And, herein lies some of the difficulty. Here a management has to decide whether it can use this financial capital better than shareholders. If it can, then it should retain the funds. If not, it should pay out the money to those that own the stock.
Microsoft paid no dividends until 2003 and has increased them 10-fold since then. Microsoft made acquisitions here and there; it added new products and services here and there, and it continued to pile up cash. And, its stock price continued to remain around the same level.
One could argue that whatever it was that Microsoft was doing with its retained earnings, that investment was not adding additional value to the stock.
And, then Microsoft began to issue debt. The first issue came in 2009. I wrote about this within the context of a lot of "healthy" companies issuing debt at that time. In 2010 and 2011, Microsoft issued more debt. The story was that "healthy" companies were issuing stock at this time to take advantage of the very, very low interest rates to prepare for an "acquisition binge" as the economy recovered from the Great Recession where there would be a lot of "not-so-healthy" companies available to be scooped up at ridiculously low prices.
For a lot of reasons the "acquisition binge" never took place. But, these companies, including Microsoft had even more cash on hand…not providing much of any additional return…showing very little Alpha.
Microsoft earned a return on equity after taxes of at least 15 percent for all of this time. The company is "cash rich" and is ranked as very strong financially. The company has a large (although declining) market share.
Yet, the stock has "flat-lined" the past thirteen years. Apparently, during this time, the investment community decided that Microsoft was not using its earnings in the most productive way.
I believe that the CEO of a company is the person responsible for maximizing shareholder value, for the creation of Alpha. Therefore, the buck stops with the CEO: it is the CEO that sets and maintains the "culture" of the organization. If that "culture" produces flat-line results over a thirteen-year period, it is that CEO who is responsible for the performance.
I certainly felt that if any company I was leading performed that way over an extended period of time when I was the CEO…then I was responsible.
According to reports in the press, the board of Microsoft did not feel that Mr. Ballmer was meeting market needs. Mr. Ballmer was a good "inside" man when Bill Gates brought him into the company. He performed very well under Gates. But, on his own, the "inside" man was not able to respond well to the "outside" world. The board finally realized this and decided to move on.
I believe that Microsoft will be a major player in the future. I believe that Microsoft has the human and financial resources to perform well in the future. I am long in Microsoft stock. I am betting that the search committee will bring in someone who can lead Microsoft into the future.
But, this CEO must be one that understands how markets and arenas behave today and can build a culture that can respond in a superior way to the opportunities that exist within such an environment. If such a person is not brought in, then I will try to be as nimble as possible moving on to another investment.
A company can exist on the competitive advantage that it has built up in the past...and produce "neat" products and "nifty" games. But, that company can see its competitive advantage slip away over time if it is not appropriately responding to the market. Just ask the folks at Blackberry. Ultimately, however, an investor has to look at the numbers…and in Microsoft's case the numbers are all declining, except for the Microsoft stock, which has modestly moved upwards since Mr. Ballmer made his retirement announcement…something that no retiring CEO wants to see happen.