I've been bashing Microsoft (MSFT) for some time now. But I'm not sure if I've necessarily been fair or clear in my criticism. I take issue with a whole host of the company's strategic pursuits, financial decisions and the like, and I believe every single word I've written in my time as a blogger.
At the corporate level, I think that Microsoft has made some tremendous blunders and continues to make countless errors of historic proportions. That said, Microsoft is filled with some of the brightest, most insightful, most forward-looking professionals I've ever met, so many that it is almost mind-boggling. A bunch of these people were my fellow campers at CI Foo, and I couldn't have been more impressed. These are people that, if given a chance, could give Yahoo! (YHOO), Google (GOOG) or anyone else a run for their money. They are on the bleeding edge, but the edge where there is money, not just science for science's sake. So what does this mean?
I'd say it is a good news/bad news story for Microsoft shareholders. The good news is that some of the human capital at Microsoft is likely among the best on the planet, and doesn't seem overly discouraged by the crazy stuff going on at corporate. If allowed to flourish, who knows how competitive this company could become. The bad, however, is that the decision-making process currently employed in Redmond has and is continuing to lead to simply awful strategic decisions on an increasingly large scale. The company is clearly trying to squander cash as quickly as it is making it, which is not the best formula for building shareholder value. So given this state of affairs, what should Microsoft be doing?
Get a cultural face-lift. As an outsider, I cannot begin to understand how decisions are made. But what I can surmise from the outside is that there has been a consistent string of decisions dating back to the late 1990s that defy logic, and that this is indicative of a systemic issue that desperately needs fixing. "Strategic" investments like AT&T (T), Comcast (CMCSA) and Nextel (S). $25 billion+ sunk into the Home & Entertainment Division (H&E) over the past five years. Tens of billions in share buybacks at relatively high prices. What are we talking here? $50 billion, $60 billion, $75 billion of foregone shareholder value? Whatever it is the numbers are staggering. Something within the culture near the top of the organization is broken and it needs to be fixed - now. Because there is another $40 billion about to be pushed out the door that is likely better spent in any number of ways. But that I'll leave until later.
Allocate capital on the basis of stand-alone businesses. The character of Microsoft's three major business lines, and even the products within those lines, are very different. For instance, the operating systems business is a cash cow. A cash cow that, given the dynamics of the mega-shift from desktop computing to web services, has the cash flow characteristics of an oil well. It has high current cash flow, cash flow that can be sustained and even grown somewhat through the use of technology (akin to using better drill bits, injecting natural gas and water to increase yield in the realm of drilling, but in the case of Microsoft means new releases, function upgrades, etc.), but that ultimately the cash flow will decline and then vanish.
This part of Microsoft is far and away the most value on a present value basis. And this is not due to rapid growth. It is due to the magnitude of the fortress they've built in the operating systems world. But this fortress cannot and will not last forever. But in the meantime, they can use the cash from this massive annuity to establish a significant dividend and to fund high-ROI R&D, not the kind of far-flung investing they've done in the past.
What this also means is that they should strongly consider spinning off the Home & Entertainment Division, a business that has cost an enormous amount of money with a highly uncertain, long-shot payoff. That said, it has some strong brands and some solid technology. It just has never had to operate with the discipline of a real business since its losses are covered by corporate's seemingly boundless largesse. It is time for the young adult to move out and live as an independent being. This would likely have several positive effects for Microsoft's shareholders: (1) stopping the flow of cash that should be going into your pocket from subsidizing additional H&E losses; (2) providing you with ownership of a potentially high-growth business that is better able to attract talent and flourish due to its independence from Microsoft; and (3) offering you the chance to sell your ownership in the H&E business if you simply think it sucks and you don't want to play the gaming game any more. As a Microsoft shareholder, 1-3 are looking pretty good to me.
Invest in Live. For life. This is the bet be made given the Microsoft's competencies and core franchise. Given the IP within Microsoft and their 30+ years of experience with desktop computing, they should be able to make a run at owning the web-services fueled computing environment. Ultimately, Microsoft is going to have to do to themselves what the market will ultimately do to them - kill their desktop franchise. But by then, they should be able to do the present value calculation of foregone annuity earnings from the desktop franchise versus the increase in breadth and long-term growth of a massive, ubiquitous web services offering. I'm not saying do this tomorrow, but senior management needs to acknowledge that this is where things are going. This is a big cultural shift for the company, but given the talent and IP already resident within Live they've go the raw materials to make this happen. I would much rather see corporate invest an incremental $5 billion in Live than as a down payment for Yahoo or some other stupid acquisition. If you want organic growth, invest in the areas you really understand. H&E? Give me a break.
This post is in direct response to my epiphany that as much as I've beaten up Microsoft, it is still one of the world's leading talent magnets. They've got it right in front of them. They just need to reach out and grab it. If they've got the vision, the stomach and the will necessary to make the cultural changes necessary to let it happen.