Samsung (KRX:005935) is eating the tech industry. Samsung is the single most important supplier in the tech sector today. This is one simple fact that many Wall Street analysts are overlooking that C-level executives at the big tech firms have been weary about for years. While many people are looking at Google and Apple as the reason for Microsoft's decline, I would argue that the biggest threat to Microsoft's return to glory is the behemoth that is Samsung. Microsoft (NASDAQ:MSFT) needs hardware companies to buy their licenses. These companies are disappearing faster than anyone would have though imaginable. It is for this reason, that it is becoming clear that an executive like Sanjay Jha is the ideal candidate to take over where Steve Ballmer left off. He has the experience and credibility to reposition Microsoft (MSFT) in the market as it will be in 5 years.
The hard facts from Microsoft 2013Q4
- "OEM revenue decreased 10%, due primarily to a declining consumer x86 PC market" (Direct quotation)
- Entertainment and Devices Division: 10,165M Revenue, 848M Profit = 11% Pre-tax Gross Margin, only 6% revenue growth last year
- Windows Division: 19,239M Revenue, 9,504M Profit = 50% Pre-tax Gross Margin, only 5% revenue growth last year.
- Online Services Division: 40% operating loss, even when growing revenues by 12%.
Let us look at the numbers for a second. Micosoft's revenue from hardware vs. software has been increasing recently, but their hardware margins are terrible. Are investors ready for 11% margins vs. 50% that the windows division was pulling in? Can Microsoft's cost structure support this? The answer: no, and no. Nobody is making money on consumer software anymore. Hardware and services are the only sectors with margins left in the business, and these margins are terribly low compared to what Microsoft has been used to for the past two decades. If we look at the trend, revenues from selling software as a platform to hardware manufacturers is going to zero, and declined 10% last quarter alone. Not only that, but Samsung will to switch to their own in-house software soon. The business case for selling operating systems is no longer valid. Why would anyone pay Microsoft to use their inferior product when the market leader is free?
Enter Sanjah Jha. Some things you should know about Sanjay:
- Sanjay knows the smartphone industry. More than Tim Cook, more than Stephen Elop. He came up with the fabless chip idea that has been so profitable for Qualcomm. He knew Morotola had no chance alone, and sold to the only business that has a chance to take on Samsung.
- Sanjay has experience taking a once massive American brand, splitting it where it needed to be split, and earning a reasonable return for investors. (see Motorola)
- Sanjay Jha is an engineer (he has a Ph.D in Engineering). Tech companies are all about talent retention, and tech talent prefer to work for engineers than "MBA" types.
- Former CEO Motorola, COO & President at Qualcomm Inc.
Microsoft's only chance to keep any of its margins in the changing tech space is to become more vertically integrated. This is not a new concept. It is the basis of Steve Ballmers restructuring. That being said, who has experience in the verticals that Microsoft is going to have to attack? Microsoft has a horrible track record when it comes to hardware. Sanjay is the ideal candidate, and he is free for the taking. He knows exactly where value is added in the supply chain, and who is ready to partner with whoever it needs to be to ensure Samsung does not continue eating the entire tech sector.
Investors need to be ready to imagine a future where Microsoft is not what it is today. It is inevitable that the business will have to be split to remain viable. They definitively lost the platform war, and have no prospects for hardware (See Nokia). If they want to stand any chance of competing with Samsung/Google in the coming decade, they need someone like Sanjay to split up the firm, and refocus the units on where they can add value to the supply chain. Microsoft, as it is structured today is destined for failure. They need someone ready to take the unpopular decisions of re-focusing their talent on high margin sectors, and splitting up the business accordingly.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.