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Renee Ann Butler is a freelance finance writer and former management consultant with over 15 years of experience in business management and strategy. She earned an MBA in financial management from Exeter in 2007 and has enjoyed a variety of international business experience, working primarily in... More
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  • Microsoft's Cloud-First Concept Not A Game Changer

    Microsoft (MSFT) is in for some changes. Satya Nadella, the company's CEO, took the reins in early February and is focused on helping the $366.55 billion market cap tech giant rediscover its core competencies while aligning its strategy going forward with the same.

    Microsoft's share price has climbed steadily since Nadella took the helm, but I'm not interested in playing the momentum.

    MSFT Chart

    MSFT data by YCharts

    The bigger question is whether the company is worth its share price and whether its real value will increase over time - and that is debatable.

    That's not to say there aren't are good things happening at Microsoft - there are.

    LOOKING AT THE NUMBERS

    The company's cloud revenue is up 147%. This section of the company's business includes the company's subscription document management and creation service Office 365 as well as Azure. The early numbers look as though Microsoft's push into cloud services will be a success, pointing to an annualized run rate of $4.4 billion.

    (click to enlarge)

    Bing also improved its ranking, taking over 19% of the US search engine market - and that could go up. Apple (AAPL) recently announced that Microsoft's Bing would be the default search engine in its iOS 8 and OS X Yosemite, and there is a possibility it will replace Google as the default search engine. The change comes after Apple made Bing the default search engine for Siri, the personal assistant program.

    Microsoft has also been doing well in cost discipline. Last quarter, the company grew gross margin by $1 billion or 7%. Granted, a push into cloud services will do that - no software installation discs or packaging - but its a strong number.

    In addition, Microsoft's revenue growth has been around 15.6%, compared to an industry average of 11%, and the company has very low levels of debt. Its debt-to-equity ratio is around 0.25 and it has a quick ratio of 2.31, showing that in addition to owing very little the company also has ample liquidity to cover its short term needs. On top of this, Microsoft's share price has been on the rise, even before Nadella took over. It's share price went up over 59% during the past three years, 42% in the past year.

    Microsoft also boasts strong cash flow. Its net operating cash flow increased over 61% compared to the same quarter last year - a stellar figure given that the average cash flow growth rate in its industry is roughly 40%. The company has also posted strong earnings per share, pulling in $2.66 per share versus $2.02 three years ago.

    Then there is Microsoft's new CEO - Satya Nadella.

    ENTER NADELLA

    While it is still early in Nadella's tenure, the CEO is getting credit for applying financial discipline while pursuing his vision for a "mobile-first and cloud-first" company. Brendan Barnicle of Pacific Crest Securities said Microsoft was "hitting on all keys" prompting the analyst to raise his rating of the company to Outperform from perform. Marketwatch quoted him as saying, "Microsoft is demonstrating unprecedented financial discipline that is applying to all of its businesses, especially Nokia."

    Daniel Ives, of FBR Capital Markets, echoed Barnicle, explaining "This guidance speaks to management's efforts to make Microsoft a "leaner and meaner" technology giant over the coming years in order to strike the right balance of growth and profitability around its cloud and mobile endeavors." Brent Thill of UBS was also upbeat, boosting his one-year target estimate to $50 from $46 noting the positive steps Nadella's leadership is taking "in both product innovation and cost controls [and] as this transformation plays out, we believe Microsoft will become more efficient in driving recurring revenue at lower costs."

    That is a whole lot of optimism, even for a CEO honeymoon period.

    Nadella seems geared towards reorienting Microsoft's efforts away from software and more towards cloud-based efforts and devices designed to make goong mobile easier. The Microsoft CEO explained vision for the company, its market, its core competencies, and the importance of the cloud in Microsoft's future as well as its hardware in a 3,200-word memo sent to employees on July 10. It was called "Bold Ambition & Our Core." One week later, Nadella sent a second email to employees, warning of a reduction in overall workforce of up to 18,000 jobs - I'd say that is pretty bold.

    The cuts came just before Microsoft released its 2Q14 earnings. The company narrowly topped revenue expectations (bringing in $23.38 billion over $23 billion expected), and missed EPS expectations by $0.05, posting $0.55 GAAP while analysts were estimating $0.60 per share. As Microsoft CFO Amy Hood was careful to note in the earnings call, the "guidance did not include the impact of the acquisition of Nokia's devices and services business. Excluding that [Microsoft] grew revenue 10% exceeding the high-end of [its] guidance range."

    But if wishes were fishes, as the old saying goes.

    REASONS FOR RESERVATION

    Microsoft has been a pioneer in many ways but the concept of becoming "cloud first" isn't exactly a headline. Really, it's barely news. Every tech company that has direct consumers of its end products is focusing on developing services for the cloud and creating a unified consumer experience across devices.

    That said, Microsoft seems much more like a hold position to me. It is well established enough that large hits to its share price are relatively unlikely, at least in the shorter term - but so are large increases. Microsoft is currently trading at roughly $44 a share and carries an average price target of $46.81 - even with its 2.7% dividend, that isn't much of a return for a would-be investor.

    Microsoft is also holding high levels of cash - at a time when the tech industry is soaring and M&A is par for the course of larger companies. It makes me question whether the company is initiating many new projects - especially since it has not kept up with its competitors' innovations.

    Microsoft is keeping its focus on business technology - a division that has traditionally brought it good success - but, that success may have run its course. Microsoft built its business decades ago by pushing its solutions through Value Added Resellers (VARs), offering bundled business solutions with the necessary hardware. And it worked. After only a few years, Microsoft emerged as a dominant force and solutions like Microsoft Office were everywhere.

    The company tried to replicate the strategy with its launch of Windows 8 but it was late to market. Developers and manufacturers had already geared offerings towards Apple's iOSX and Google (GOOG)'s Android when Microsoft's Win8 debuted.

    Going forward, Apple's recent partnership with IBM (IBM) is bound to take its toll. It will bring a large amount of resources and potentially additional devices to Apple's already dominant position. In addition, the partnership between Apple and IBM means that there can be a new series of VARs for the enterprise markets.

    Microsoft may see a small piece of this thanks to Apple's inclusion of Bing, but it won't be nearly the extent of the success Microsoft enjoyed in the past. Over time, as Apple and IBM bring to market the fruits of their partnership, Microsoft will have increasingly less footing in the business technology markets.

    GOING FORWARD

    It's time to stop the love fest and treat Microsoft like any other company. Nadella is pushing the company in a new direction - a necessary step. The question investors have to ask themselves is whether they believe Microsoft has the capabilities to become a leader in a cloud-first, mobile-first world - and how well the tech giant can stand up to its rivals.

    In addition to navigating the waters of competitive technology, Microsoft may also have legal challenges to face. The company is under investigation by China. On Monday, government investigators visited Microsoft offices in Beijing, Shanghai, Guangzhou, and Chengdu. Reuters quoted a source close to the company as saying that the visits were likely related to an antitrust investigation. Qualcomm (QCOM) is currently facing penalties which could exceed $1 billion in a similar probe.

    While an investigation does not presume guilt, should Microsoft be hit with similar penalties, the impact on its share price, and, to a greater extent, the company's flexibility moving forward could become an issue.

    The company may be able to get the right people on board and introduce software that will run consistently and dependably, but it won't be right away. These things take time, and the company's share price is bloated right now. And, the business avenues Microsoft has depended on in the past may not be there.

    Keep Microsoft as a wait and hold position - at least until after the honeymoon.

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

    Jul 29 5:22 AM | Link | Comment!
  • Yahoo's Biggest Problem Is Its Name, Not Google

    Yahoo (YHOO) has a big problem. The once-great company needs to do something to remain relevant. Even its email addresses are being spurned in professional communities, with job advice boards specifically advising candidates NOT to use an @yahoo email address, likening it to @hotmail or @aol address (the latter of which coincidentally shares many of the same security issues as Yahoo).

    With such a poor public perception of the Yahoo moniker and the company as a whole, perhaps Yahoo would be better off if it started over and changed its name altogether.

    KEEPING UP WITH THE TIMES

    Yahoo has lost a lot of ground in recent years. The company's homepage still looks roughly like it did in 2002; the only real difference is a different font and a slightly different layout.

    (click to enlarge)Yahoo

    (click to enlarge)Yahoo 2014

    And why even have a homepage? They are passe. Roughly one-third of people in the US primarily go online using a mobile device, with mobile usage poised to eclipse desktop usage by 2015 - and mobile devices generally do not use homepages. Yahoo rival Google (GOOG) shut down its version of a homepage, called "iGoogle," last year. Google explained the reason, stating that "with modern apps that run on platforms like Chrome and Android, the need for iGoogle has eroded over time, so we'll be winding it down." So why doesn't Yahoo follow suit?

    Even Yahoo's email is out of date. Its features, its color scheme, its perception all need a boost. Yahoo has tried several times since Mayer came on board to revamp the mail system but so far it has not been met with a very warm reception. The New York Times called a recent attempt the "online equivalent of a riot." One frustrated user wrote, "The new Yahoo is so bad it's tragic," while others complained the company was trying to mimic Google's Gmail.

    YAHOO MAIL

    Yahoo Mail is a "big deal" for Yahoo, writes Vanity Fair. "It has an estimated 275 million users, and while no one on the outside knows the precise numbers, there's an assumption that well over half of Yahoo's traffic originates with people who come to check their mail. In other words, if Yahoo loses those people, there could be a ripple effect."

    And then there are the security issues. The company has been besieged lately. The attacks took Yahoo's servers down several times, spurring the company into actions which, while may have helped the issues, resulted in a rash of bounced messages.

    These issues are bad enough in and of themselves, but don't forget that Yahoo offers a premium email service called "Ad Free Mail" for $49.99 a year - many of these complaints are from PAYING customers.

    Revenue from the company's display ads has also been on the decline, while Google's share of the global digital ad market is rising and newcomers to the digital ad market like Facebook (FB) are starting to take root. Pageviews on Yahoo sites have definitely improved under Mayer - traffic to Yahoo sites actually beat out traffic to Google sites last July. But if this trend is indeed related to email users and Yahoo finally loses them for good, the company is going to take a major hit - losing both pageviews and income from premium email subscribers.

    But it's not as if Yahoo CAN'T do it.

    A FEW FALSE STEPS

    Let's not forget, Yahoo was an industry leader, once upon a time. In the years leading up to the dot-com bubble, Yahoo had a total market value of over $100 billion and seemed poised to give rival Google a run for its money. Then, in 2000, Yahoo and Google teamed up. Under the agreement, Google became Yahoo's default search results provider. The deal was meant to be a complement Yahoo's network. Before long, people started bypassing Yahoo and going straight to Google - and it was all downhill from there.

    YHOO Market Cap Chart

    YHOO Market Cap data by YCharts

    At one point, Yahoo had a good infrastructure and the addition of CEO Marissa Mayer has helped. The company's share price has swelled by 33% in the last year, and 155% since Mayer joined the company. Some of that is the honeymoon effect, but she has made several big moves with big potential, such as the acquisition of Tumblr and the addition of Yahoo Yodelers - and then, of course, there is Alibaba.

    YHOO Chart

    YHOO data by YCharts

    ALIBABA

    Once Alibaba has its IPO, Yahoo will walk away with a 16% stake in the company and a fresh influx of cash - a payday of as much as $48 billion in cash. There will obviously be a large tax burden but hopes remain that Yahoo CFO Ken Goldman may be able to find some sort of work around to minimize Yahoo's tax bill after Alibaba's public offering.

    One big possibility is that Yahoo will use the money to further foreign investment, possibly continuing the company's push towards overseas video assets and ability to compete against Google, "which generates a higher portion of its ad revenue overseas" according to Cantor Fitzgerald's Youssef Squali in a recent article by the Wall Street Journal.

    But maybe Yahoo's problem isn't its overseas standings or its recent acquisitions? At some point, Yahoo is going to have to focus on identifying its core, building up its reputation, and securing its infrastructure.

    GOING FORWARD

    Yahoo could start over and rebrand its efforts. Google has routinely launched services which it later shutdown. Like iGoogle or Google Video, the efforts weren't wasted. By and large they were integrated into the broader Google framework. Google Video went into YouTube and iGoogle became integrated into enhanced search results and Chrome extensions.

    Yahoo could do the same thing, in reverse.

    Yahoo has functioned as an aggregate (that is what a homepage does, after all) - why not remove the middle man - itself? The company could take the services that work, secure its infrastructure, and wrap the whole package up in a new brand. Imagine a Tumblr that integrates into a photosharing site, email, messaging service, and media platform? Email that lets you share whole photo albums and videos, as well as a message, at a click of a button. A home site that aggregates content from blogs you follow, rather than filling in the squares of a homepage.

    The money from Alibaba's IPO could be used to execute just such a plan. All it would take is an improved infrastructure, a little programming, and a killer marketing team.

    Tumblr already has greater user buy-in amongst its users than Facebook or Twitter. According to Tumblr founder and CEO, David Karp, members spend an average of 14 minutes per visit, which is 90 seconds longer than Facebook and a few minutes longer than visits to Twitter. And, perhaps more importantly, Tumblr is more popular amongst younger users than Facebook - a fact that will sure take more importance going forward.

    Value-added additions could be layered over the web, as well as email and social media. The result would be a unified experience, pushing Internet services into a magazine type structure - and all of that could be monetized with targeted ads.

    Mashable quoted Karp as saying that people spend more time on Tumblr because it is "so much better." Karp explained: "It's very different behavior. People come here for same reason they turn their TV on when they come home at the end of the day ... It's something to do before checking your email, it's a chance to go and see stuff you enjoy, let's you escape from the real world."

    And his comments tie directly into Mayer's vision for Yahoo. Mayer has long said that "media has long been one of Yahoo's key strengths" and that she wants to "harness the power of the web and deliver it in a concise experience, like that found in the beautiful, elegant magazine."

    Interactive sections that add value to content are already part of Yahoo News Digest, which uses the Summly acquisition to blend stories from a variety of sources into a morning and evening overview of top news stories for the day, and further value is added to these stories using interactive sections called "atoms" which add images, videos, and even Wikipedia entries. Why not apply it to the entire Web experience?

    TAKEAWAY

    Until Yahoo takes solid steps to build the framework and infrastructure for its services, pushing its efforts across the brand into a unified, consistent, and reliable framework, investors should take a step back and wait and see - Alibaba or not.

    But if Yahoo puts the huge chunk of change it has coming into rebuilding and possibly rebranding its efforts, the company just might be able to reclaim its seat at the head of the pack. The change won't happen overnight and Yahoo has made enough false steps that I wouldn't expect its share price to reflect its efforts straight away, but it is worth keeping the company on your radar.

    Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

    Tags: GOOG, FB, YHOO, long-ideas
    Jul 29 5:18 AM | Link | Comment!
  • Microsoft Looks To Cloud For Xbox One, But Is It Worth Your Investment?

    Physical media is so 2000 and late. First, CDs gave way to digital music thanks largely to Apple (NASDAQ:AAPL) iTunes. Then, buying DVDs started to fall to the wayside as more people turned to services like Netflix (NASDAQ:NFLX). Now, Microsoft (NASDAQ:MSFT) is changing the way people game.

    Xbox One

    Microsoft's new Xbox One, available in November, does things a little differently. The system operates in the cloud. This means users can access their games from any Xbox One -- your entire game library will be stored in the cloud whether you install your game via disc or digital download. However, there are restrictions -- games will stop working if you go 24 hours offline and you can forget about loaning, renting, or selling your games, except to approved retailers.

    At its E3 press conference on June 10, 2013, the company announced that it would be releasing 13 next generation titles available exclusively on Xbox One -- including the new Forza Motorsport 5 which allows user "drive-a-tars" learn the way you drive and uses that profile to race competitors even while you are not playing -- but that doesn't mean Microsoft is kicking Xbox 360 to the curb.

    A New Xbox 360

    Xbox 360 will still be around. In fact, Microsoft announced a new version of it available June 10. The new device has a look similar to the Xbox One -- all dark and sleek -- and it is quieter. But, that doesn't mean Microsoft wants you to buy one or the other over the Xbox One. In fact, the company is trying to drum up sales through its gold member program. Beginning July 1 through the release of Xbox One, Gold members will receive two free game downloads, including titles like Assassin's Creed II and Halo III.

    Don't worry, the upcoming releases of Grand Theft Auto V and Final Fantasy XIII will still be available on Xbox 360 -- as well as the new World of Tanks, which is only available on Xbox 360.

    Fundamentals

    Microsoft's E3 conference may put a pretty spin on its Xbox business, but less than a quarter of the company's business comes from online services and entertainment. The real question for investors is whether or not the company is worth the investment -- and right now, things are not looking good. Microsoft is trading at $35.30 on a 52-week range if $26.26 to $35.78, with a one-year target estimate of $34.36.

    What's more though, looking at the company's current fundamentals compared to its past performance, there are some big warning signs.

    Microsoft's operating margin is at 29.5%. This may be higher than 75% of the companies in its industry but it is on the low end of the company's performance over the last 10 years, during which its operating margin ranged from 24.5% to 50.9%. Microsoft's revenue growth has also slipped, coming in at 7.5% on a 10-year range of 6.3% to 15%. And, insiders are noticing. David Einhorn slashed his fund's position in the company by nearly 44% during the first quarter, while Steve Cohen cut his stake by roughly 70%.

    Conclusion

    The new Xbox is only going to take Microsoft so far. The tech titan has been pursuing restructuring toward a more "devices and services" oriented company and launching some other efforts such as discounted rates on its Windows RT (a version of Windows 8 for tablets) and pushing its Office platform to the cloud (Office 365) -- but that doesn't mean those efforts are going to push Microsoft into generating large returns for investors, especially over the short term.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Jun 10 1:47 PM | Link | Comment!
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