Seeking Alpha
Long/short equity, value
Profile| Send Message| ()  

For the past decade, Microsoft's (MSFT) share price has been somehow stagnant. However, according to the outgoing CEO, Steve Ballmer, it is the market that is failing to recognize the company's value. Understandably, some may view this as an excuse but if you think of it, he has a point. However, it's during Ballmer's tenure at the helm of the software giant that saw the share price fall from the highs of 50s (in January 2000) to 30s and then remain stagnant ever since.

Currently, Microsoft boasts of strong underlying fundamentals and I do agree with Ballmer's sentiments that as long as the company continues to make investments which have the capability of leading to valuable products that people will pay for in a way that generate profits, its stock price will definitely respond to that. In one of my articles (Finally, Microsoft Makes the Key Shifts Investors look for), I said that Microsoft's consumer side was decent and its commercial side was also impressive. My arguments in the article are based partly on the company's impressive FY13Q4 earnings reports. The other bit of my argument is based on Microsoft's future and its ability to transform into a device and service business.

As confirmed on Tuesday, Nov. 19, 2013, Nokia (NOK) shareholders overwhelmingly approved a $7.2 billion deal which allows Microsoft to purchase the ailing cellphone and services division plus a portfolio of patents from the Finnish tech giant. The approval was widely expected considering that Nokia's share price has more than doubled since the announcement of the deal back in September.

The specifics of the deal indicate that Microsoft will pay 3.79 billion euros ($5.12 billion U.S.) for the Finnish giant mobile unit and the remaining 1.65 billion euros ($2.23 billion U.S.0 is for a ten-year license to Nokia's patents, with an option of extending it indefinitely.

How Nokia Fits into Microsoft's Future

The Nokia-Microsoft deal is expected to be completed in early 2014. However, the big question is how exactly does Nokia fit into Microsoft plans? Considering it is not yet clear how Microsoft plans to integrate the Lumia and Asha lines with its internal structure that also features Windows Phone marketing. Nonetheless, the deal could mean that names such as "Nokia Lumia Windows Phone" could be a thing of the past. In a business sense, the deal allows Microsoft to focus on marketing the Windows Phone and increase its market share from Q3 levels of 3.6% (per IDC).

Also, the deal marks a significant step toward the company's resurgence in the consumer electronics sector. This means that Microsoft is on its way to transition into being an all-in-one provider of consumer electronics, integrating its software and hardware just like it is the case with tech giant Apple (AAPL). However, the strategy has so far witnessed some mixed results with the fourth fiscal quarter results indicating that the company's devices and consumer revenue growth of 4% to $7.46 billion. Its Surface revenues grew to $400 million, a far cry from what Apple did with its iPads during its recent quarter, but at least it is a start.

The Perennial Question of Microsoft's Stock Price

At least some credit should be given to the outgoing CEO for initiating the transition. Still, it is his 13-year stint at Microsoft that has seen the company miss the resurgence in the consumer electronics and cloud computing. Nonetheless, in his tenure as the CEO of the software giant, Ballmer has managed to triple Microsoft's net income. In his response to a question from a shareholder at the annual shareholders meeting, he said, "Our stock price is 60 percent, maybe, of what it was when I took over as CEO. Profits are three times what they were when I took over as CEO…"

Indeed, he was right with his statistics because if you check Microsoft's net income in 1999 (the year before he became CEO), it was $7.8 billion, approximately a third of the $21.8 billion in 2013. Certainly, that is a disconnect, how come profits tripled while the stock price are down by about 60%? At that point, I think it is safe to conclude that the market is failing to appreciate Microsoft's strong underlying fundamentals as evidenced by its revenue income for the past decade.

Specifically, what has been hindering the growth of Microsoft's share price in most cases has been as a result of:

1. The failure of the company to excel in "big growth areas." By this I mean, in the tech sector, investors often go for high-tech companies e.g. Apple, Google (GOOG) etc. which show the potential for big future growth. As you may note, in the last decade, Microsoft's performance in the big growth areas, notably mobile and internet, wasn't that impressive. It is therefore suffice to say that up to now, there is a belief that Microsoft is past its best days. Maybe that is the reason as to why investors are still hesitant to pay a premium for the stock.

2. Furthermore, in recent years, not many approved of Steve Ballmer's leadership, a point made clear with an approximate 7% gain in share price back on Aug. 23, 2013, after he announced he was stepping down from the top job. Ever since, speculation has been in the air that Microsoft is looking to replace Ballmer with either Ford's (F) CEO Alan Mulally, current former Nokia CEO Stephen Elop, Microsoft cloud boss Satya Nadella or former Skype CEO Tony Bates.

Final Thoughts

The previous failures of Microsoft to seize the opportunity in the big growth areas is definitely one of the reasons as to why its share price has been stagnant. Critics say that Microsoft has always been slow to respond to the booming mobile device market. However, Microsoft's strategy has always aimed at getting the first step right when it came to the mobile device market. Mind you, mobile has always been a weakness for Microsoft but still the company recognizes the tremendous potential of the mobile device industry.

From a strategy point of view, the Nokia deal is a perfect step, perhaps one that clearly confirms the underlying value of the company. I strongly believe the Nokia deal is a bold step toward the company's ambition of transforming into a devices and service business. It is high time the stock market stopped punishing Microsoft by realizing its underlying value.

Source: Is The Stock Market Failing To Recognize Microsoft's Underlying Value?