How Microsoft Can Win

Tim Travis profile picture
Tim Travis

Microsoft (NASDAQ:MSFT) is often regarded by market participants as yesterday's news, overshadowed by the faster growing innovators of our era such as Apple (AAPL) and Google (GOOG). While he is likely a nice guy, I believe CEO Steve Ballmer has been a real problem for the company. A horrendous capital allocation and M&A record has overshadowed some real solid business developments. In this article, I will discuss my plan on how Microsoft can compete effectively as technology goes mobile, and how the company can set itself up to win over the long run. I'm not an IT expert by any means, so I encourage discussion on how some elements of the plan can be accomplished most effectively.

The first step I would take as CEO of Microsoft would be the acquisition of Research in Motion (RIMM). Currently, the company has a $5 billion market capitalization, and likely trades below the value of its net cash and patent value. RIMM can be a key to Microsoft's mobile plan, particularly with RIMM getting close to launching the transformative Blackberry 10 offering powered by QNX. I understand that both the BlackBerry and Microsoft brands are out of favor among many consumers who are part of the Apple and Google bandwagons, but on the Enterprise side of things, both companies are highly regarded. RIMM's email and security has always been the best for corporations, and Windows and Office are integral to most businesses' everyday operations. Combining the two companies enhances the end-to-end offerings of Microsoft and consolidates the mobile field. All future mobile R&D and marketing expenses could be streamlined to integrating the BlackBerry 10 capabilities, with those of Windows phones. The actual integration of the two is beyond my circle of competence, but I believe that the additional financial strength of Microsoft would immediately allay concerns that some consumers have that RIMM won't be able to sustain investing in its own operations over the long-term in this increasingly competitive industry. Alleviating this concern would boost initial sales of BB10, while providing time for Microsoft to incorporate key features of Windows mobile with those of BlackBerry. Also in this era of patent wars along the mobile space, the purchasing of RIMM's deep patent portfolio would help protect Microsoft from future litigation. As part of the acquisition, I would focus on licensing the BlackBerry 10 operating system to other OEM manufacturers such as current MSFT partner Nokia (NOK). The mobile market would be dominated by 3 well-financed companies, Apple with iOS, Google with Android, and Microsoft with its combination of Windows and BB10.

I believe Microsoft would be extremely competitive with Android in particular, which isn't known for being the most secure mobile software at this point in time, although I'm confident Google can rectify any issues over the long term. The big mobile carriers such as Verizon and AT&T have been large subsidizers of Apple's phones, so increased competition might eventually be able to reduce the amount of those subsidies, improving margins. Therefore, I believe they would be willing to be quite promotional for the Windows phones, and I think we have already seen that with Nokia's more limited current offerings. Application developers would only have 3 operating systems, enabling smaller developers to reach a larger percentage of mobile users at a lower cost. Microsoft could really hammer the Enterprise market, promoting the ease of intertwining Windows and Office with its mobile offerings, and through licensing to other OEMs, Microsoft will be catering to the "bring your own device" (BYOD) trend. A combined BlackBerry and Microsoft could more easily manufacture its own phones and tablets, and the increased scale would boost margins. Apple's operating system is much more ideal for casual photoshop-type users, than for handling large scale business operations, and combining Microsoft's offerings with RIMM's high quality security would make for a real fight. Someone like myself would never buy another Apple product, because I don't want to be tied down to their whole ecosystem. Open architecture will win out, and it is essential that Microsoft embraces that as Google already has. RIMM's largest shareholder is the respected value investor Prem Watsa, and I believe that a $15 offer would be able to get the deal done, as the obvious synergies between the two companies would likely create a tremendous amount of long-term shareholder value. I can't reiterate enough how important this is to MSFT, as winning at mobile will protect market share for its Office and Windows products, which generate the vast majority of MSFT's earnings.

The second step I'd take is to more aggressively look to enhance the developing partnership with Facebook (FB) pertaining to the Search business. Bing's algorithms rank well when tested with Google, but Microsoft needs to shift the perception of its appeal, and working with Facebook could possibly accomplish this. Searching through Facebook is not an easy process, and I believe that by utilizing Bing's more comprehensive Search results, Facebook users would have a better Search experience. Google is directly taking Facebook on with its Google+ offering, so Facebook is incentivized to help Microsoft, which is a 1.6% shareholder of FB, to win, or at worst compete more effectively. Perhaps combining both Facebook and Microsoft's display advertising businesses would make sense to fully leverage the overall offerings to better compete with the incumbent display advertising leader, Google. Social networking is here to stay and leveraging the relationship with Facebook makes a ton of sense for Microsoft, which has often been late to the innovation party. Similar relationships with LinkedIn (LNKD) and Twitter, among others, would be smart as well. The Search business is not one that is likely to be spread out among many competitors, so anything Bing can do to gain market share should pay lasting dividends. On the same topic, it might make sense to at least inquire with Yahoo (YHOO) CEO Marissa Mayer to see if Yahoo's display advertising business could be combined with Microsoft's for a reasonable price, beyond the current partnership. There is talk of Yahoo and Facebook working on a Search collaboration, and I believe that it would make sense for these companies to work together to compete against the Goliath in advertising that is Google. Yahoo's market cap is just over $21 billion and much of that value is in its Asian assets. The display business has been profitable but it is not growing for Yahoo, and nobody knows more than Mayer how hard it is to compete with Google, so increasing scale dramatically is the only realistic option to significantly grow market share.

Lastly, I would aggressively adjust the capital allocation model. I'd immediately raise, at a minimum, $10 billion of long-term, fixed-rate debt. This could likely be accomplished below 3%, which is less than the current dividend yield of Microsoft. I'd use the funds to buy back stock aggressively at current prices. This shouldn't be a one-time thing, but instead should be a strategic focus over the next decade, with a heavy weighting over the next 3-5 years as interest rates are artificially low due to the Federal Reserve's quantitative easing program. I know this might be somewhat controversial, but I don't believe it would be a bad idea to buy 3-5% of both Hewlett-Packard (HPQ) and Dell (DELL) around current prices. A 5% stake in Dell could be bought for around $790MM currently, while 5% of HPQ could be bought for about $1.3 billion. Both stocks have dividend yields in excess of 3%, and are undervalued in my estimation, therefore would be far more prudent than Microsoft's current capital allocation strategy of hoarding cash. It is important for MSFT to show some support for these embattled PC makers, and ultimately if a decision is made to spin off the PC divisions at some point, perhaps we could see some consolidation in that market, and Microsoft needs to protect its position as software provider.

Utilizing this cash in a disciplined, value oriented manner, will put an end to outrageously priced acquisitions like the disastrous $6 billion aQuantive deal that was recently written down almost entirely. It also puts a focus on improving per share value. I'll put out a research report on valuing Microsoft at a later time, but I believe strongly that these steps would be highly accretive to Microsoft shareholders. This is a great company that shouldn't be resigned to losing, but I don't believe the current chief executive is up to the task. Companies like IBM (IBM) have provided a clear example of prudent capital allocation for maturing IT companies. Every business is different and I can understand the trepidation that Microsoft has had in making radical changes. I applaud Ballmer for his development of the Entertainment division, and the inroads in virtualization, but these are minor businesses for MSFT. The company has seen its wide-moat diminished, and it is time to act definitively and consistently. I encourage productive discussion as I'm sure there are readers that have much more technical "know how" than I do, but at this stage of the game capital allocation and strategy will be key determinants in the future of MSFT's stock performance.

Disclosure: I am long MSFT, RIMM, YHOO, HPQ, DELL, GOOG. 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.

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Tim Travis profile picture
Tim Travis is a veteran deep value investor and money manager. Travis has extensive experience in traditional investments such as stocks and bonds, in addition to having a unique methodology of combining options and distressed investing with value investing to generate income, reduce risk, and to add an element of timing. Currently Tim Travis is the founder, Chief Executive Officer, and Chief Investment Officer of T&T Capital Management. T&T Capital Management is a Coto de Caza, California based Registered Investment Advisor that manages accounts for both individual and institutional investors. Travis was born in Laguna Beach, California and became captivated with the value investment philosophy in his early teens through reading books written by Benjamin Graham, and the shareholder letters from Berkshire Hathaway, and the Buffett Partnership L.P. Tim Travis became intrigued by the notion that stocks aren’t just pieces of paper but instead are fractional shares of a business that can be analyzed by comprehensive analysis of the balance sheet, income statement, and statement of cash flows. He majored in Business and Economics at the University of California Santa Barbara, graduating in 2004, and he also had the privilege of studying international economics at the University of Richmond in Florence, Italy. Tim Travis got his feet wet in finance working for both Scottrade and AG Edwards & Sons during his college career. Upon graduation Travis worked at the Vanguard Group in Scottsdale, Arizona. It was there that he learned that most mutual funds underperform their respective indexes, and he became disappointed at the overwhelming diversification in most mutual funds, that really makes most of them function as “closet” index funds. After leaving the Vanguard Group, Travis worked for a small futures and commodities firm in Mission Viejo, California. It was there that Tim developed an adept knowledge of options, particularly the selling of options to take advantage of the higher probabilities involved. It was also during this time in his life that Travis began reading everything he could possibly find on value investing. Some of his role models in the field are Warren Buffett, Martin Whitman, Bruce Berkowitz, Seth Klarman, Peter Lynch, Glenn Greenberg, etc. After working with clients from around the world Travis broke away and started T&T Investment Management L.L.C. At T&T, Travis refined his unique methodology combining value investing, with the selling of options to generate income and reduce risk. T&T experienced explosive growth by partnering with a local commodities firm. After several years Tim Travis realized that without controlling the majority of the company any longer, he didn’t have full control over the company’s strategic direction. Divergent business principles caused Tim Travis to break away and form T&T Capital Management. At TTCM which Tim Travis is the sole owner, he is allowed to offer only the best products and services, at a reasonable price, without conflicts of interest. T&T Capital Management’s goal is build wealth for both individual and institutional investors, and to accomplish these goals Travis as Chief Investment Officer employs his deep value investing techniques. Each account is managed on a day to day, personal basis, and there are no cookie cutter portfolios defined only by one’s age and risk tolerance. Every security is researched and hand selected by Travis and his research team. T&T Capital Management takes pride in first class customer service and research which is regularly communicated to clients for education purposes.

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