- The new CEO of Microsoft has made an encouraging first step.
- The company can take additional steps to unlock shareholder value.
- The shares are attractively valued especially if the new CEO shakes up how Microsoft does business.
"Don't find fault, find a remedy." - Henry Ford
Microsoft (NASDAQ:MSFT) rose some 4% yesterday to touch highs not seen since before the internet bust. The driver of the rise was an announcement that Microsoft will make its Office software available and compatible for Apple's (NASDAQ:AAPL) iPad. The software apps will require an Office 365 subscription.
I think this is an encouraging initial move for Microsoft's new CEO, Satya Nadella. Although being available for the iPad only means a possible $2B to $3B in additional annual revenue for Mr. Softie, it is a good first step towards positioning Microsoft as a mobile and cloud first company.
It also shows the new CEO is not afraid to do business in a different way as this collaboration with a major competitor has been a "sacred cow" that just was not done under Stephen Ballmer. Here are a few more "suggestions" for Mr. Nadella from a long-time shareholder:
- Ditch the Surface. It has a tiny market share, is a low margin business and puts the company in competition with some of its OEMs as well. Apple has won this battle as Microsoft missed the move to tablets and has never been able to crack the code for selling consumer devices outside the Xbox.
- Buying Nokia's (NYSE:NOK) handset business was Mr. Ballmer's last splash so the new CEO is probably stuck trying to integrate it into Microsoft as seamlessly as possible. However, if the business cannot garner a respectable 10% to 15% market share over the next two years, it will be time to jettison this business as well.
- If Microsoft acts on my first two suggestions, it also should spin off its Xbox business. This will leave the company as a pure software play which should result in better overall margins and a higher multiple awarded from investors.
- The iPad is a good first step, but more is needed to focus investors on the company's burgeoning "cloud businesses." Both Azure and Office 365 doubled sales over the last year and are now both billion dollar revenue businesses. Microsoft is now the second largest cloud software developer by revenue, but few investors understand or have rewarded this development.
I am encouraged by Mr. Nadella's first step and hope he can continue to make shareholder friendly moves. He has a lot to work with. The company has an AAA credit rating and over $60B in net cash and marketable securities on the balance sheet. In addition to its fast growing cloud businesses, both Windows license sales and server software revenues are growing in the low teens.
More importantly, Mr. Nadella has the benefit of timing. Unlike Mr. Ballmer who was appointed at the end of the internet boom when the stock had sky high valuations, Mr. Nadella begins his tenure with the stock attractively valued. The shares go for 14.5x trailing earnings and seeing revenues grow in the 6% to 9% annual range. This overall market is selling at ~17x trailing earnings and analysts expect the S&P 500 to produce only 4% sales growth in 2014.
Throw in an almost three percent yield (2.9%) and the stock still looks attractive in an increasing volatile market. If Mr. Nadella continues to shake up how Microsoft does business, it could be a very rewarding few years for its long suffering shareholders.