Just How Risky Is Microsoft?

May.16.12 | About: Microsoft Corporation (MSFT)

I still find it humorous the transition of investor's perception of Microsoft (NASDAQ:MSFT) in the past few years. Analysts used to refer to it as "dead money", but it has come out of the recession as one of the fundamentally strongest corporations and has radically begun changing its business strategy for future growth. This article serves to analyze and understand Microsoft in terms of financial and market risk imminent to it now and in the future.

Financial Risk

Liquidity

Analyzing and understanding where Microsoft stands, with respect to liquidity, isn't as easy as 1,2,3. Microsoft has two particular liabilities accounts which should be removed from liquidity calculations, because they're not actually liabilities which pose liquidity danger. These accounts are called the Short-term unearned revenue and Long-term unearned revenue accounts. Essentially, these are pre-paid services, by clients, which will be converted into revenue/income after being used. Because of what these liability accounts actually represent, I believe they should be excluded from the liquidity calculations.

Upon the temporary exclusion of these accounts, Microsoft's adjusted 2011/2012 cash and current ratios become:

Adjusted 2012 cash ratio: 4.86

Adjusted 2011 cash ratio: 4.04

Adjust 2012 current ratio: 6.28

Adjust 2011 current ratio: 5.74

The cash ratio represents Microsoft's instantaneous ability to pay off short-term debts while its current ratio, which represents its short-term ability to pay off short-term debt. I've spent much time analyzing liquidity metrics for other corporations and was absolutely set back by these numbers, which is why I had to re-calculate them three times to verify that I'm seeing these figures correctly. Essentially, Microsoft is currently able to fully cover the entirety of their short-term debt obligations 4.86x over (meaning for every $1 in current debt, they have $4.86 in cash, cash equivalents, and short-term investments to cover the debt) and 6.28x over when accounting for all their liquid assets. We've seen a trend towards higher liquidity quarter-over-quarter, even in the midst of Microsoft preparing for its grand scale Windows 8 release this Fall.

Our primary focus when looking into a corporation's fundamentals is to view how they're currently doing; however, these metrics become even more useful when juxtaposed against other similar corporations. In my opinion, Microsoft's current greatest competitors are Google (NASDAQ:GOOG), Apple (NASDAQ:AAPL), and Oracle (NASDAQ:ORCL). Their adjusted liquidity metrics, net of unearned/deferred revenue accounts, are:

Google

Adjust 2012 cash ratio: 6.2

Adjust 2012 current ratio: 7.33

Apple

Adjusted 2012 cash ratio: 1.06

Adjusted 2012 current ratio: 1.89

Oracle

Adjusted 2012 cash ratio: 5.56

Adjusted 2012 current ratio: 7.02

Averaged liquidity ratios among Microsoft, Google, Apple, and Oracle:

Adjusted 2012 cash ratios: 4.42

Adjusted 2012 current ratios: 5.63

Apple's apparently low short-term liquidity seems apparently low simply because most of its investments (assets) are in long-term securities, which aren't included in short-term liquidity calculations. Microsoft's short-term liquidity measures are truly outstanding, but when juxtaposed to its peers, are slightly lagging behind; however, at this point of extreme liquidity, it serves much less importance in knit-picking at liquidity. Microsoft has done a remarkable job in managing its debt obligations, which aids in stabilizing its stock price amid future economic surprises. Currently, Chesapeake (NYSE:CHK) has experienced severe stock price depreciation due to natural gas prices tanking, which has led to dangerous liquidity levels; the stock has been hammered down 23.7% this month alone, in major response to future cash flow restrictions, limiting its ability to pay off current obligations.

Risk management is one of the most important values in equity investments, but is also the most overlooked. We've seen time and time again where investments backfired simply because of risk being overlooked. If you can't think of any examples, just consider the current global economic crisis we're in; triggered through negligent risk management of mortgage-backed loans, securitized by investment banks that didn't truly understand the underlying risks, and insured by companies that didn't accurately measure the risk of the underlying investments. The common theme here: risk. Financial risk, in this article, is measured through debt obligations and the ability to hedge against them. In my analysis, Microsoft has leveraged itself effectively in a manner allowing it to hedge against short-term and long-term financial risk; however, financial liquidity is only one measure of risk. Another, and more pressing risk, is Microsoft's ability to maintain its market edge through the massive multi-market transition currently taking place.

Market Risk

Microsoft was significantly propelled in the late 90's because of Windows 95, but its position of near-monopolistic market control has quickly subsided. It's currently competing against tech giants like Google and Apple in the rapidly changing marketplace. Microsoft's most imminent and pressing market risk comes in its ability to secure a strong position in the mobile and tablet marketplace, which it has attempted doing, but has historically failed tremendously.

Market research by Credit Suisse projects that global smartphone sales are expected to grow nearly 46% this year to 687.9 million units and to 1.05 billion units by 2014. Market research by IDC projects that global tablet sales are expected to reach 106.1 million units this year and to 198.2 million units by 2016. The leading platforms for these technologies belong to Google's Android and Apple's iOS, with Microsoft lagging far behind with only 3.9% mobile market share. In my previous analysis of Microsoft, I analyzed the critical importance of Windows 8 success to Microsoft. They've been losing market share on operating platforms at a far accelerated rate to projections; most of these losses to Google and Apple. In my analysis, Windows 8 will be Microsoft's critical component in reclaiming its lost market share and creating value for its shareholders.

Why, exactly, is Windows 8 game changing, not only for Microsoft, but for the industry as a whole? It's the most aggressive full-fledged attempt at integrating desktops, laptops, netbooks, tablets, smartphones, and anything utilizing an operating platform. It's the seamless integration of all these products into one. It's Microsoft most aggressive attempt at penetrating the mobile and tablet markets, while growing its marketshare in desktop, laptop, and netbook markets. Competitors like Google and Apple have taken incremental approaches towards multi-product integration, but Microsoft has taken the most aggressive approach with its Windows 8 release. If this platform is a success, which many view it to be, then it will propel Microsoft into deeply penetrating the mobile and tablet markets it has tried so hard to do in the past. If this ambitious attempt fails, though, then will all hope be lost? I don't believe so, but I do believe that its shares may take a fair beating as a result.

Consensus

In my two-fold approach at gauging Microsoft's financial and market risk I've concluded that though it excels in its ability to remain financially secure, its market risk is tremendous. The success of Windows 8 undermines Microsoft's short-term and long-term profitability. Historically, Microsoft's Windows platform on smartphones hasn't fared well against the Android and iOS platforms, but the utility provided by Windows 8 should help Microsoft in penetrating both the mobile and tablet markets. They've received tremendous support by mobile carriers, like Verizon, and by tablet manufacturers like Dell (NASDAQ:DELL), HP (NYSE:HPQ), and Lenovo. The massive supply-sided support will definitely help Microsoft in generating exposure and adoption of its Windows 8 platform; initial exposure which will serve paramount importance in the penetration of Windows products into multiple markets to generate future profitability.

In the end, though, the market is the ultimate decider. Microsoft's Windows 8 is completely new and with it, comes drastic changes people may or may not like. Microsoft has historically shown an ability to rebound from failures and I believe Windows 8 will be their ultimate rebound.

Disclosure: I am long AAPL, CHK, LNG, AIG.

Additional disclosure: May re-initiate a position in MSFT