On Tuesday night, the AP reported that Ford (F) CEO Alan Mulally will not leave to become Microsoft's (MSFT) next CEO. In the after-hours session, Microsoft shares fell over 1%. Over the past month, many analysts had been suggesting that Mulally was unlikely to move to Microsoft, which may explain the relatively muted reaction. Since peaking in early December, shares have fallen more than 6% as the "Mulally premium" exits Microsoft. With Mulally out of the running, there appear to be three remaining front runners: server/cloud chief Satya Nadella, ex-Nokia CEO Stephen Elop, and ex-Skype CEO Tony Bates. Given the stock's performance over the past month, it would appear that the market is disappointed that Mulally is not taking over the tech titan. I think this view is misguided.
Simply put, Alan Mulally's core competencies did not align with Microsoft's needs at this moment in time. While at Ford and Boeing (BA), Mulally has shown two areas of tremendous expertise, neither of which are relevant to Microsoft. First upon taking over Ford, Mulally proved to be an adept crisis-manager, taking out $23 billion in debt in 2006, including mortgaging the Ford brand. This decision proved to be brilliant when the company avoided a cash crunch during the financial crisis.
Microsoft faces no financial crisis. If anything, the company has an embarrassment of riches with a cash balance that exceeds $80 billion. The company's balance sheet health is the polar opposite of Ford's. The only question is how much capital to return shareholders through dividends and buybacks. Microsoft has no need for a financial crisis manager.
Second, Mulally is an expert at optimizing the manufacturing process. He completed projects at Boeing on time and within budget. Mulally right-sized the cost structure at Ford to deliver strong profits and impressive operating margins. He successfully negotiated lower labor costs, cut excess capacity in Europe, and implemented the "One Ford" strategy to build cars with global appeal, which makes manufacturing and R&D easier and less costly. With weekly roundtable meetings every Thursday, Mulally also improved collaborations among Ford's various business units to build better ideas and a more cohesive strategy.
Microsoft has no labor cost issue and is not a manufacturing company. It does not need a CEO with an expertise in manufacturing. While Mulally's ability to build a cohesive corporate culture is useful, many individuals have that capacity. Microsoft cannot afford a CEO who has to learn on the job when it comes to the company's main lines of business. Mulally is not the man to realign Microsoft to thrive in a changing tech environment.
The challenge for Microsoft is growing new businesses to offset declines in its legacy Windows business. Xbox has been a fantastic unit for the company with the Xbox One selling an impressive 3 million units. Similarly, Bing has built a decent 15-20% market share. While it won't be overtaking Google, it is a solid ancillary business. With its acquisition of Nokia's mobile phone unit, Microsoft is making a major push into mobile, which is critical for the firm's growth going forward. Cloud computing offerings can also further entrench Microsoft's relationship with enterprise.
While Windows may have seen its best days, Microsoft has the capacity to be a company that continues to grow for years ahead thanks to these growth businesses. Microsoft needs to choose a CEO who has an understanding of where these markets are going so that MSFT can position itself appropriately. I believe the three remaining front runners would be great choices to lead Microsoft into potential growth markets.
Windows and Office remain cash flow machines while Xbox has the potential to become a leading entertainment hub. Given the size of the market, there is definitely room for another major mobile player beyond the iPhone (AAPL) and the Android (GOOG) universe. With Nokia's strong brand overseas and tremendous financial capacity, Microsoft can over time become a major player in smartphones and tablets.
MSFT investors should be relieved that Mulally will not be the next CEO as he did not have the right skill set for the job that needs to be done. As it has become clearer that Mulally is not taking over, we have seen MSFT trade lower. With earnings power in the $2.80-2.95 range in calendar 2014, shares are now trading around 12-13x earnings while offering a 3% dividend. If you factor in the company's net cash position of $8 per share, the stock is trading at less than 10x earnings. Investors should use this sell-off to buy Microsoft as the stock remains cheap and is poised to pick a CEO who will guide the company to growth in coming years. Mulally was never the right man for the job, and investors should be glad he is no longer in the running.