To begin with, a shout out to Seeking Alpha's new initiative of publishing "collaborated" articles. Skyler Greene and I decided to present the bull and bear case respectively of Microsoft (MSFT) as part of this new initiative. You can read Skyler's bull argument here. Since Skyler begins his piece by defending the Microsoft management, let us begin on the same topic in this article as well.
- The Leadership (or the lack of it): Steve Ballmer has been at the helm since January 2000 and the journey for investors has been less than stellar since. While one might say he took over after the company had seen its best days, a CEO is expected to be a game-changer, not someone who just drags along based on past laurels or even worst, drags you lower. When a company's CEO is featured on the top 5 worst CEOs list (at a time when there are plenty of candidates for the few spots), you do not want to place your money there.
- The Share Price: The lethargy of the management clearly reflects in the share price. Microsoft was trading at $29.70 on September 24 2003. And the price at close on August 4th 2012 was $29.75. The range bound nature of this stock over the past decade (and expected in the future as well) make it a nice trading stock but not a good investment anymore. Including dividends, the decade long returns to investors in the period mentioned is about 20%. PE compression is certainly a factor like Skyler has mentioned in his article but that also shows the market did not and does not expect any sort of growth.
- Lack of Focus: Like Google (GOOG) and Amazon (AMZN), Microsoft is an expert at doing many things but not many of them right. Products like Xbox, Windows Phone, Bing have clearly lagged the industry leaders. Successful companies always establish the success of one product before moving onto the next. Apple, for example mastered the iPod before releasing the iPhone and the same applies to iPad.
It remains to be seen what the tablet introduction (Surface) results in. Since Skyler used Trefis to quote the target prices, let us look at what Trefis says is the impact of all these "new" products that Microsoft built after its glory days. Oh yes, all those ventures combined contribute about 6% of the stock price, the lowest of the lot hands down. (Hey, does anyone even remember the Zune still? Ya, the supposed iPod killer. )
This ties back directly to the first point - the CEO and the company in general is living on its past products and is clearly lacking a distinctive new product/service. In fact, even the best part of Microsoft's business - the operating system had a miserable hiccup in the form of Vista, released in 2006. It was such a disaster that people longed for Windows XP, a product that was launched in 2001. So you never know how Windows 8 is going to turn up. But some initial review comments like this one aren't encouraging -"Perhaps its biggest problem is that it has two separate and largely incompatible parts. It feels like Microsoft took a nice dress and attached it to an equally fine pantsuit and tried to pass it off as one garment. It just doesn't work." Read more here about Windows 8.
- Better Stock Alternatives: If you are looking for a solid growth, go with Apple (AAPL) and Google. If you are looking for strong dividend plays in technology, your best bet is Intel (INTC), which has a higher yield and lower payout ratio than Microsoft. Despite having 5 times Intel's $13 billion in cash and cash equivalents, Microsoft has left many investors wanting more dividends. And it is not just investor greed. It's because the company could afford to pay investors more instead of blowing cash on so called R&D.
* - As Skyler mentioned in his piece, the recent numbers were impacted adversely by a $6 billion write off.
- Competition: While the previous point addressed the stock alternatives that are better than Microsoft, this is about its business competitors. Fighting Apple in the tablet space, for example is something that many have tried doing but failed miserably. While Skyler is right that the iPad growth does not necessarily kill off the PC market overnight, even Microsoft admits that its tablets will outsell PCs. While this might sound like good news to Microsoft because of Surface, if tablets dominate as expected, it will be iPad that dominates. iPad currently accounts for 68% of the market share. If there is a distant second, it will likely be the Android tablets. To use an Olympics analogy, Microsoft could at best hope for the bronze after Apple and Google take the Gold and Silver in this market. Jokes of Microsoft's "slippery surface" are making the rounds already.
- Bludgeoning Expenses: Microsoft has been throwing money at research and (lack of) development like crazy. With an average pile of products as mentioned above, this seems like cash down the drain. Agreed its cash pile is huge but take a look at the chart below and when you think of innovative companies, the one at the extreme right is not the one on your mind. A company spending almost 4 times more than Apple in R&D is coming up with lame versions of products that Apple revolutionized years ago.
To quote Peter Lynch, Microsoft seems to be "di-worsifying" in stead of creating value for its shareholders. That low PE and PE compression that Skyler touched upon will be thrown out of the window if Microsoft continues spending cash like this.
World to Microsoft: You cannot buy innovation.
Conclusion: So, there is your bear case of Microsoft. Skyler, as usual, has done a fantastic job of presenting the bull case. Read both versions and decide which side of the story you agree with and invest accordingly.
Disclosure: I am long AAPL.