There seem to be thousands of articles written about Microsoft's (MSFT) valuation, poor leadership and stock price. I am surprised, quite frankly, that by now no one has coined, "Steve the Stink Ballmer." People are calling for his resignation even though the underlying business performance has been pretty great.
There is no doubt that Microsoft is cheap at these levels. A P/E of 10, throwing off loads of free cash flow, low debt, tons of cash, great returns on assets and equity and a solid projected earnings growth rate of 10% plus. The important questions to ask at this point are:
- What will probably happen in Microsoft's future domestically and internationally?
- Can Microsoft's business prospects generate enough investor optimism to move the needle on the stock price?
- How much intrinsic value has Microsoft built for itself over the years?
The purpose of this article is to answer these questions and to build a case that Microsoft is undervalued relative to its intrinsic value and its moat is bigger than people think. I will do this by addressing the following areas from a QUALITATIVE perspective:
- Microsoft's moat is bigger than people think.
- Microsoft's poor marketing and branding in the consumer segment are fixable.
Note: There is a TON of information out there on the quantitative factors, but in my opinion, it is the qualitative factors about the Microsoft's future that are holding Microsoft's stock at low levels. Microsoft has been performing in terms of revenue and earnings growth.
People are worried about the wolves at Microsoft's door named Google (GOOG) and Apple (AAPL). There has been a tremendous amount of negative press generated about Microsoft by authors who need readers to earn a living. In my opinion, they tend to over exaggerate to get more readers. I think the press does this in general.
As someone who has done many an IT audit in his career, I can tell you that Microsoft's enterprise and business products are entrenched and growing in the business world. I find it difficult to see things like Active Directory, SQL Server, etc. going anywhere anytime soon.
Fear about the future of Windows and Office products is what is really keeping the stock price down. Business and personal purchases of Office and Windows are Microsoft's bread and butter. I think these fears are over exaggerated in people's minds similar to when everyone thought that email would kill regular mail. I still get a ton of mail, including birthday cards, post cards, etc. Microsoft's products are "stickier" than people give them credit for. There are so many social and lifestyle dynamics that keep people using the same product day in and day out and create a moat for a company like Microsoft. Does anyone really think that a consultant, a lawyer, or a finance professional is going to work in Google Docs? When these people go home, do you think they will want to use Google Docs? I have yet to see anyone give a presentation in an important meeting with a Mac or anything other than PowerPoint. Does anyone really think that families are ONLY going to have IPads? Plus, Windows 8 is going to be pretty sweet. The majority of people will always default to Windows, because they use Office products and they will always opt for a cheaper computer, particularly now that Microsoft has stepped up its game with Windows 7 and 8.
People are worried that the cloud model won't be as profitable for Microsoft. I honestly think that most people will still have Office installed on their computers. The cloud will help Microsoft in the business world, because people can access their docs anywhere. It will probably be adopted as an add on service. People may use the cloud version for working on a tablet in the airport or something, but most people will prefer the experience of the installed version. What if there is no internet connection? You don't get to work? I think Microsoft has a huge moat.
Microsoft's consumer business is where most of the debate occurs because Microsoft has dropped the ball on more than several instances. This has people believing that Microsoft cannot innovate, can't execute, etc. The reality is, Microsoft is a B2B business at heart and does produce great technology. Microsoft has just stunk at selling to the consumer. However, I think Microsoft will begin approaching the consumer better. If you have seen the new Windows 8 video, I think this is evident.
Microsoft's Marketing Issues in the Consumer Segment are Fixable:
Microsoft has a brand problem caused by lack of focus on its consumers and lack of passion to produce consumer products that change lives.
However, this is good news. Brand problems are fixable when product improvements are made and Microsoft is making them. Ford (F) is a great example of this. Not long ago, in most people's minds, FORD stood for: Found On Road Dead. People could not imagine this changing. Brand improvements trail product improvements. People are again thinking the Ford brand is quality. I believe this is going to happen with Microsoft. Microsoft can make great products and if marketed correctly, these products sell, i.e., the XBOX Kinect. Microsoft does produce great technology and can sell it if they brand it correctly.
There are many things in Microsoft's favor right now. They are executing well domestically even though people love to hate them. They have a solid operating system for phones which Nokia (NOK) is going to push it into developing countries where everyone has heard of Skype. This will make these phones familiar and desirable. These phones will win on price and still offer solid quality. Many of these international folks will use Bing. I believe that international adoption of Bing is possible and we will someday see Bing making money. Microsoft cannot beat Google and Apple here, but they can overseas. It is totally different internationally. When I go to Jamaica, they LOVE Blackberry phones and I am thinking what the heck? Really? After phone purchases, most will buy the less expensive PC.
When you factor in these opportunities, Microsoft is undervalued. I believe that the days of complacency at Microsoft are also ending. Any improvements to its brand and marketing will be a boon.
I think Microsoft will continue to be a cash cow even if it never fixes its brand problems, but I think it will and once it does, watch out. It is not like I don't like Apple and Google stock, I do. They are great companies. I think there is room for everyone to grow. However, you have to be contrarian if you are going to make money in the stock market and Apple has already made a huge move. I think there is quite a large margin of safety for someone buying Microsoft at this point and it is a good deal. I am long Microsoft.