Microsoft - Attractive Valuation As Investors Discount The Company's Cash Balance

Jul.22.12 | About: Microsoft Corporation (MSFT)

Shares of Microsoft (MSFT) ended Friday with losses of 1.8% after the software company reported its fourth quarter earnings report on Thursday after the close. Investors reacted negatively after the company reported its first quarterly loss ever.

Fourth Quarter Results

Microsoft reported a 4% increase in non-GAAP quarterly revenues to $18.1 billion. The company took a $6.19 billion impairment of goodwill and deferral of $540 million on revenue related to Windows Upgrade Offer. As a result of these charges the company reported an operating income of a "mere" $192 million and reported a loss of $0.06 per share. Non-GAAP revenues came in at $18.6 billion with non-GAAP operating income coming in at $6.93 billion, or $0.73 per share.

"We delivered record fourth quarter and annual revenue, and we're fast approaching the most exciting launch season in Microsoft history", according to CEO Steve Ballmer.

Annual Revenues & Segments

For the full year of its fiscal 2012 Microsoft reported GAAP annual revenues of $74.3 billion, which is up 6% on the year. GAAP operating income rose 5% to $28.5 billion, and earnings per share rose a similar percentage to $2.78 per share.

Windows & Windows Live Division

The personal windows division reported a 1% decline in annual revenues to $18.9 billion. Operating income fell 6% to $11.5 billion. The company released the pre-release of Windows 8 during the final quarter of its fiscal 2012. The final version will become available in October of this year.

Server and Tools

The server and tools division reported a solid 12% growth in annual revenues to $18.7 billion. Operating profitability improved 18% to $7.4 billion. The SQL Server and System Center division each reported solid growth in the fourth quarter.

Online Services Division

The online division of Microsoft reported 10% revenue growth to $2.9 billion. Excluding the $6.2 billion goodwill charge the division still reported a loss of $1.9 billion compared to a loss of $2.7 billion last year. Search engine Bing managed to expand its market share by 120 basis points to 15.6%

Microsoft Business Division

The Microsoft Business Division reported a 7% increase in annual revenues to $24 billion. Operating income rose 7% as well to $15.7 billion. The $1.2 billion acquisition of Yammer announced in June of this year will be placed under Microsoft's Business Division. Social networking features will be incorporated into the existing product line.

Entertainment and Devices Division

The entertainment and devices division reported a 7% increase in annual revenues to $9.6 billion. Operating income fell to $364 million, down from $1.3 billion last year. Microsoft recently announced that the next version of Windows Phone operating system will be based on the same core as the Window PC operating system.

Balance Sheet

The company ended its latest quarter with $63.0 billion in cash, equivalents and short term investments. The company operated with $12.0 billion in short and long term debt for a net cash position of $51 billion, or little over $6 per share. The market values the firm at around $30 per share or roughly $250 billion. Excluding the net cash position of $51 billion, the market values the operating assets around 2.7 times annual revenues and 8.5 times 2012's annual GAAP earnings. Additionally the company pays a quarterly dividend of $0.20 per share, for an annual dividend yield of 2.7%, equivalent to an annual payout of almost $7 billion.

Investment Thesis

Shares of Microsoft have returned 16% year to date trading within a $28-$32 price range. Shares have traded around this level for years now as investors worry about Microsoft's tolerance for losses when building new divisions. They furthermore worry that the company will use its massive cash balances to make expensive acquisitions. In June the company paid $1.2 billion for Yammer and last year it bought Skype for $8.5 billion. The fourth quarter loss is entirely attributable to an acquisition, namely that of aQuantive in 2007 as Microsoft took a $6.2 billion write-off on this acquisition.

As such investors structurally undervalue the business as they are afraid the company might squander its cash balance on even more future acquisitions. However if we exclude the massive net cash balance of $50 billion shares still trade at just 11 times annual earnings while still providing a 2.7% annual dividend yield. Even if the company occasionally makes an expensive acquisition, the core of the company provides enough value for a long term investor.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.