Internal candidate Satya Nadella has just been named the new CEO of Microsoft (NASDAQ:MSFT). It is one of the most challenging leadership roles among large-cap tech companies. He will be replacing longtime leader Steven Ballmer and also will have to deal with a founder - Bill Gates - that will become more "involved" in the new structure.
I hold Microsoft in my portfolio and will be watching closely how the new leader starts to put his imprint on the company. In my opinion, he will have at least three major decisions to make once he gets a handle on his new role.
Spin off or keep Xbox and Bing:
This will be one of most speculated on decision points for Mr. Nadella. Xbox recently launched its first new console in seven years which is seeing good sales results. Unfortunately, this is a lower margin business than software and one that consistently posts losses.
The company has maintained this is a portal into consumers homes and will eventually pay off in a big way. That remains to be seen and I believe the company blew an extraordinary chance to accelerate their penetration into the home market by not picking up Netflix (NASDAQ:NFLX) when it was trading for less than $100 a share in early 2013.
If Microsoft cannot figure out how to better penetrate the home consumer market and/or start to post consistent profits in this division, will Mr. Nadella have the courage to spin off Xbox into a separate more focused company that might have better success as an independent concern?
Bing has been a distant second to Google (NASDAQ:GOOG) in search for years. This division consistently posts losses and Yahoo (NASDAQ:YHOO) is dissatisfied with its current search arrangement with Microsoft. The division has also been a disaster in mobile search due to the low market share in smartphones Microsoft currently has. Google has dominated this search space via its very successful and free Android platform. Part of whether to sell, spin-off or shut down this business will be driven by the outcome to the second decision point below.
Win or go home in mobile:
One of the biggest jobs Mr. Nadella will have in the early months of his tenure is to ensure the successful integration of the ~$7B purchase of Nokia's (NYSE:NOK) handset business and its 32,000 employees into the bigger corporate organization.
He also needs to understand that Microsoft has a "window of opportunity" in the smartphone space. The telecom carriers desperately wants to viable third play in the mobile OS space besides Apple and Google. That gives Microsoft a chance to gain market share in this critical area.
However, Microsoft has never done well in the consumer space outside of Xbox. The company needs to get some "wins" in the marketplace over the next 18-24 months and gain some momentum. If it doesn't, it pretty much also makes the decision on Bing easier as the company has to win here to gain a foothold in mobile search.
If the company does not show it can play in this space within two years, Mr. Nadella needs to have the will to get out of the mobile hardware space much as Google recently did by selling off Motorola Solutions (NYSE:MSI).
Emphasize Cloud and Enterprise:
One of the most frustrating parts of being a Microsoft shareholder over the past year and a half is the problems in the above areas is overshadowing the company's core strength in the enterprise as well as its accelerating success in the "cloud."
Enterprise server software sales and Windows licenses grew 12% Y/Y in the last reported quarter. The company's two cloud offerings (Azure and Office 365) are now billion dollar plus revenue businesses. Sales in both doubled year-over-year in the recent quarter and they are high margin businesses in contrast to Xbox and Surface.
Mr. Nadella should watch Saleforce's (NYSE:CRM) earnings calls and how a master communicator like Marc Benioff works the word "cloud" into almost paragraph. Microsoft is the number two cloud software concern based on revenue, but few investors associate Mr. Softie with the fast growing cloud space. That needs to change. Look for activist ValueAct to push Microsoft to better emphasize these businesses as well.
Valuation and Other Considerations:
Mr. Nadella has some good cards to play. The company just posted its best quarter in years recently, easily beating on top and bottom line consensus. It also has over $60B in net cash and marketable securities on the books and an AAA credit rating.
The new CEO should also benefit from the low expectations on the stock currently. The shares sell at ~12.5x forward earnings, a 20% discount to the overall market multiple. This valuation does not take into account its huge cash balance either.
The company is growing revenues in the 6% to 8% annual range, significantly higher than the 4% sales increase currently expected in 2014 for the S&P 500. Finally, the stock has a 3.1% dividend yield.
Microsoft is an easy investment case to make from a value perspective. If the new CEO can make the right decisions in the areas listed above, investors can look forward to the stock also being mentioned more frequently as a growth play. The will lead to Microsoft being awarded a higher multiple and stock price in the marketplace. BUY
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.