AmTech initiates coverage of Microsoft (MSFT) and calls it "one of the most compelling investment opportunities in technology":
We believe that excellent fundamentals in MSFT’s core Client and Business segments will drive upside to conservative consensus estimates through CY09.
[HB: Logic makes sense]
Also, long-term challenges from virtualization, open source, and virtualization necessitate MSFT achieve success in the Internet Advertising space.
[HB: "Necessitate that Microsoft achieve success"? That sounds like a negative, no?]
We believe that the most likely scenario is for MSFT to acquire YHOO near the current offer price with potential for significant revenue and cost synergies in the long-term. As investors look past dilution/integration concerns - which we view as overblown - to longer-term growth, we believe the stock will see significant multiple expansion.
[HB: Logic makes sense]
MSFT has declined sharply since the YHOO offer and is trading near its lowest forward P/E, EV/EBITDA and P/S multiples since 2000, providing an excellent entry point. If the deal does not materialize, we would expect to see appreciation to the mid-$30's as uncertainty is removed and investors focus on strong fundamentals.
[HB: Agree completely]
Our $44 price target is 20x our C09 EPS estimate of $2.18 for the combined entity. We believe the higher multiple is justified as we estimate earnings have the potential to grow 16%-17% in C2010 and C2011.
For three reasons, we agree with AmTech that there is probably a 12-24 month trading opportunity in MSFT here:
- At 15X trailing free cash flow, the stock is cheap.
- If Microsoft pulls the Yahoo (YHOO) bid (small chance), its stock will pop.
- Microsoft is far more resistant to economic weakness than any other big tech company.
For other reasons, however, we would be extremely wary of just buying and holding Microsoft for the long term:
We believe the shift to cloud computing represents a disruptive force that Microsoft will struggle to power through. This shift, in our opinion, will attack both of Microsoft's two huge cash cows: Windows and Office. These monopolies will likely allow Microsoft to continue to show strong cash flow growth for a couple more years, but after that, we think growth will get a lot more challenging.
We believe the decision to buy Yahoo and double-down on a consumer web advertising business is a strategic error. We believe Microsoft would be smarter to buy Salesforce.com and other software-as-a-service providers that would help it solidify its hold on the enterprise--not bet a fifth of its value on a business that is at best tangential to its core strenths.
We do not believe Microsoft can fight and win wars on three major fronts: Against (IBM), Oracle (ORCL), and the emerging SaaS providers in the enterprise, Apple (AAPL), Sony (SNE), RIM (RIMM) and others in consumer gadgets, and Google, Time Warner (TWX), Viacom (VIA), et al, in consumer advertising. We therefore believe Microsoft should consider breaking itself into at least two and probably three companies. We also believe, however, that CEO Steve Ballmer is adamantly opposed to even considering this.
Disclosure: Author owns about 100 Microsoft shares.