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Included in this analysis are a number of different factors which will influence the recommendation offered at the bottom. We will start with the corporate buyback program at Microsoft, then we will proceed to discuss Vista, Zune, and the X-Box, and finally take a look at the technical picture.

Corporate Buyback Picture

In 2004 Microsoft announced a decision to buy back up to $30 Billion worth of stock between then and 4 years from the announcement. In a recent conversation with Steve Ballmer he was questioned about additional corporate buybacks. His answer was, 'we'll buy back stock when it's the right time.' According to the company's 2006 annual report Microsoft completed the $30B repurchase program as follows:

click to enlarge
msft buyback

The company has now integrated an additional buyback program which has allocated $36.2 Billion worth of common stock repurchases through 2011. However, Steve Ballmer's decision, and the obvious delay which took place after the 2004 announcement, lend thought to the question of timing. When will these repurchases take place? When does Steve Ballmer believe the right time actually is?

On August 18th the company announced that it intended to buy 155,000 shares at $24.75. Clearly Mr. Ballmer thought the time was right then. But how about now, 20% later? Keep your eyes open for addition corporate repurchases, or lack thereof. These may be a telling sign given the recent decisions of insiders as you will read later in this article.

VISTA

Without first using Vista it is hard to say how good or bad the new operating system is. Therefore, I'll approach this analysis with the idea that Vista has a development cycle typical of other Microsoft Products. The normal development cycle suggests that Vista will have some bugs during this initial roll out. When the first round of Business Clients get Vista they will almost surely have some problems with it. This is Microsoft's way of testing the waters, and I support the method 100%. With feedback from actual users of the system Microsoft will be able to weed out the bugs and the product, when it is launched to the public, will have a much more seamless appeal. This is good business and it helps to satisfy the end users over time.

However, it's not all roses. Vista is coming out at a very bad time. I expect the prior product delay to adverse to Microsoft's immediate bottom line. This will probably be a moot point after 2007 has come and gone, but for now Microsoft is likely to feel some pain from that delay and the resulting ill-timed rollout. There are a few reasons why.

First of all, Vista will not be widely adopted by all business users initially. They will wait for the kinks to be worked out before they adopt the operating system company-wide. Therefore the potential revenues from the business segment will be less than what is expected initially. Again, that will change over time, but the initial revenues are likely to be lackluster at best.

Second, the rollout to the retail public will occur after the peak selling season has come and gone. This, on top of the worst PC selling Market since 1992. According to a report issued by the US Commerce Department, PC sales and sales of related products declined by 25% in October. That's the lowest it has been since 1992. Everything considered, the rollout of Vista to the retail market will almost surely be disappointing initially.

Assuming that Vista is a quality product, there are still serious problems with the rollout and we should not expect those problems to be nullified until, probably, late 2007.

X-Box 360

Video games and consoles are clearly becoming the way of the future. This, not only for normal video games, but also for educational tools, and, from the looks of Wii, for exercise too. But why is X-Box special? That's the real question here. The current frenzy in this segment seems to be surrounding PS2 and Wii; the X-Box is a quiet third. The simple answer is availability.

I expect X-Box to be the best selling console this Christmas. But that's not because X-Box is the best product. Even though I understand that many gamers would tell you that the "Gears of War" is one of the best video games out there, X-Box itself seems to be lagging slightly behind it's peers in quality.

So why will X-Box be the best selling console this December? Availability! X-Boxes are available at most retail outlets, where PS2 and Wii products have a limited supply. This all comes down to manufacturing efficiency, and Microsoft has won this part of the battle.

Although X-Box will almost surely outsell it's rivals this December, I expect that to change in the months ahead as the manufacturing cycles of PS2 and Wii gain traction.

ZUNE

Zune is nothing special; not yet. I do not expect Zune to be a competitive threat to the iPod for a number of years. Zune is in its first developmental stage, and as product cycles go at Microsoft, development usually takes 2-3 stages before the products become competitive. Look at X-Box for example. The first generation simply was not up to par, but after some redevelopment, the consoles compete. Hopefully the same thing will happen with Zune, but that won't matter to the immediate bottom line. Zune, thus far, is a disappointment and it will likely remain that way for the foreseeable future.

Insider Sales

This piece may actually be the most interesting piece of this analysis. Before I continue, please understand that insider selling happens for a number of different reasons, so we cannot assume that insider sales are a negative indicator. However, we can identify patterns within the insider sales cycles which may shed some light on the facts. In relation to MSFT, there are clear patterns within the insider selling decisions as reported to the SEC.

Specifically, regular sales occur by insiders at Microsoft throughout the entire year. Bill Gates, for example, usually sells millions of shares every month. However, between August 8th, 2006 and November 2nd, 2006 there were no recorded insider sales. This table, should make the details more clear:

msft insiders

This table tells us that insiders have been waiting to sell their stock. 39% of the sales that occurred this year took place in the month of November, when the stock was peaking. The normal selling patterns (even the selling patterns of Bill Gates) stopped right before the company released news that it had repurchased 155,000 shares of common stock at $24.75, and then the selling resumed when the stock approached it's peak. This begs the question, were insiders expecting higher share prices and a better selling price based on the rollout of Vista and Zune? Are they now expecting the stock to decline? Interestingly the stock price increased by about 20% between 8.8.06 and 11.2.06. They made the right decision to wait, but they clearly are deciding to sell much more aggressively now that the stock has increased. This may be a leading indicator that the stock has peaked.

That point should raise some eyebrows.

Technical Analysis

Take a look at this chart and then continue with the analysis:

msft

Microsoft has just broken above longer term resistance according to our analysis. Initially this is a bullish sign. In fact, this will continue to be a bullish indicator so long as MSFT remains over that converted level of longer term support. Remember, if longer term resistance breaks higher it is converted into a level of support. Therefore, if converted support holds I expect MSFT to continue to trend higher. However, if MSFT breaks back below longer term converted support the opposite will happen and the stock will almost surely decline back to $22.46. Longer term converted support is therefore a clear inflection point. It will tell you if you should hold the stock, or sell it/ short it with a downside target of $22.41.

Conclusion

Microsoft is an ideal short candidate for the coming week. This is all based on the stock's ability to remain above former longer term resistance. I do not recommend MSFT long going into this week, but rather I recommend the stock as a short if it breaks back below converted longer term support.

If the stock breaks below converted support, I suggest shorting MSFT and expect it to decline overall this week. If the stock is above converted support though, I don't expect the stock to decline. If the stock is above this former resistance level, I suggest exercising a stop loss on any open short positions instead.

Source: Microsoft: Some Serious Question Marks