Microsoft: Proving That Slow Growth Does Not Mean Slow Death

Feb.27.12 | About: Microsoft Corporation (MSFT)

It always intrigues me to think that for a company the size of Microsoft (NASDAQ:MSFT), with a $260 billion market cap and seemingly everywhere in the PC market, continues to get disrespected in the manner that it has. I get it, Wall Street does not think too kindly of its management, but I think a bit of perspective in terms of where the company is today is long overdue. I can't help but think that Microsoft continues to be punished because it is not Apple (AAPL) - but then again, no one else is. The company faces a daunting task of trying to battle how it's perceived by analysts as well as its own investors. But I think the best way to assess Microsoft and its value is on its own performance rather than on what Apple is doing.

Slow growth is not slow death

When it comes to Apple, the reality is that Microsoft will always fall short because as close as they both appear - the truth is, they couldn't be any more different. Apple is a dominant brand with consumers where, for the most part, Microsoft has generated a greater percentage of its revenue from the corporate enterprise environments. However, where both companies begin to separate is when using the ever-popular term "growth." One is growing by leaps and bounds and the other is …well, not growing enough (for some).

In that regard, it's a pretty safe bet to think that the gap that separates the two companies will only continue to widen - particularly with the increased popularity of smartphones, cloud computing, free apps and the supposed imminent "death of the PC", it seems everything is now working against the Microsoft. But with all of this noise being thrown around, it seems that many have forgotten that Microsoft is still very much a relevant factor in PCs, servers, enterprise software, as well as many other markets. So the notion that "slow growth" somehow means "slowly death" could not be farther from the truth. And the company has recently proven that with its latest earnings report.

The quarter That Was

Microsoft reported better than expected numbers, much to the surprise of many. In addition to topping analysts' estimates, the company reported revenue that met forecasts despite its previous warnings of slower PC growth - a warning that followed an analyst downgrade of Intel (NASDAQ:INTC) due to similar concerns. But in spite of that, the company posted fiscal second quarter earnings, excluding items, of 78 cents per share, up from 77 cents in the year-earlier period. Net income was $6.62 billion, down slightly from the $6.63 billion a year ago. Revenue was $20.9 billion, a 5% increase from $19.95 billion a year ago, helped by its Office, server software as well as Xbox businesses.

The figure was also boosted by the first inclusion of revenue from Skype, the online phone firm that the company acquired last year, and a one-time gain of $225 million from favorable foreign currency rates. Investors loved this report and sent shares higher in after-hours trading. This affirms what I have been saying for quite some time which is, although the company is no longer growing to the extent of the late 90s, it still clearly remains a technology force.

Looking into the future

It seems there are very few analysts who share my optimistic view in terms of the company's long term prospects. There is growing evidence that Wall Street does not give Microsoft enough credit for being able to transition itself with time accordingly. But I think this is where a mistake is being made. The company understands and appreciates this reality and has been working to adjust accordingly - particularly with its efforts to make a more workable platform for mobile devices.

To that end, it has partnered with ARM Holdings (NASDAQ:ARMH) to license its chip technology which is a different architecture than what it has been comfortable with Intel. All of this is on top of its Windows8 launch as well as its position for the cloud - something for which I feel the company is not sufficiently credited in the same breath as database giant Oracle (NASDAQ:ORCL) and the aforementioned IBM as well as Google (NASDAQ:GOOG). There are indeed plenty of catalysts for investors to get excited about. But I also think that the company should continue to do exactly what it is doing which is focusing on its own operations and less about external factors that it is unable to control.


Investors and analysts want growth and I have no doubt that Microsoft would love nothing more than to oblige. I think that if the company can find ways to spin off some of its businesses, I suspect not only will this allow investors to have more realistic expectations, but it may also surprise investors by showing that it can once again grow. I continue to feel that the value of the segmented pieces could ultimately exceed that of the current business. But as it stands, the company has a business with very good returns on capital, excellent cash flow, and solid markets. An investment in Microsoft will likely take some time, but as one of the companies on the market with a respectable dividend yield, it may be worth it to wait.

Disclosure: I am long MSFT, AAPL, ORCL.