Microsoft: An Objective View of Ballmer's Successful Leadership

| About: Microsoft Corporation (MSFT)
This article is now exclusive for PRO subscribers.

It is extremely difficult to read an article or enter a discussion regarding Microsoft (NASDAQ:MSFT) stock without listening to angry investors flame Ballmer for his mismanagement of the company over the past decade. The purpose of this article is to refute many common MSFT misnomers regarding poor management and limited growth by providing an objective view of MSFT's performance under Ballmer's leadership.

Brief background (Wikipedia):

Steve Ballmer joined Microsoft in 1980 as Microsoft's 30th employee. In January 2000, Ballmer was officially promoted to CEO although Gates remained to provide "technological vision." Ballmer's personal wealth is estimated at $14.5B landing him at #46 on the Forbes' list of billionaires.

Stock performance (the elephant in the room):

Ballmer is commonly chastised for "destroying capital" during his tenure at Microsoft, and by looking over stock performance, it's easy to understand why shareholders have been frustrated. As Ballmer took the reins of MSFT in January 2000, the stock was trading at a range of $50-$58 (split-adjusted). In July of 2011, Microsoft had peaked at $27.55 with a local maxima of $31 in April 2010. Roughly speaking, Ballmer has presided over an annualized 5.7% loss in share value.

Financial Metrics:

Revenue Growth: Over the past 10 years (FY01 to FY11), Ballmer has presided over a revenue growth of 10.7% annualized.

EPS Growth: Over the past 10 years (FY01 to FY11), Ballmer has presided over an EPS growth of 15.1% annualized.

Operating Cash Flow: In FY2011, MSFT had an operating cash flow of $27B, which represents an annualized growth of 7.2% over the past ten years.

Net Cash: Microsoft had $23.8B in net cash in 2001. Microsoft ended 2011 with $40.9B in net cash. This includes $76.2B spent on share repurchases over the past 6 years, 7 years of dividend payments (including a one-time special dividend), and several mini-acquisitions ($8B Skype deal being the latest).

Transition to a Dividend Stock:

At the end of FY2004 (July '04), Microsoft had $60.6B in net cash. The company issued a special dividend of $3/share alongside its newly established quarterly dividend of $0.08/share, and began a massive share repurchase program.

Including the $3 special dividend, MSFT has paid out $6.51 per share in dividends over the past 7 years. MSFT has annually raised the dividend every year except in 2009. The 7-year annualized dividend increase is 10.4%. The 3-year annualized increase is 13.3%, and the 1-year increase is 23.1% ($.13 to $.16). Microsoft has managed this strong recent dividend growth while still only hitting a dividend payout ratio of 22.4% (based on FY11).

5 of the last 6 dividend increases (4 of the last 4) have occurred in November. Based on Microsoft's massive cash pile either a large dividend increase, or a substantial one-time dividend is inevitable. Historically speaking, it will be coming in November - you heard it here first.

Share Repurchases:

Throughout the past 6 years, Microsoft has spent $76.2B on share repurchases. These massive repurchases have resulted in a 23.2% total reduction in diluted shares between 2004 and 2011. Annually, this represents a 3.7% reduction in diluted shares outstanding. Coupled with the current dividend rate, this represents a 6% annual return to shareholders.

Microsoft has been able to financially sustain large share repurchases and a steady dividend increase

New Products (new found momentum?):

To limit the speculative properties of this article (which I have limited to the Skype area), I will only provide a list of new Microsoft products that appear to be gaining strong traction. A full examination of Microsoft's new ventures could easily fill another article (or two).

--Xbox 360 Kinect (already proven with a 30% annual revenue increase and 114% annual profit increase in the Entertainment and Games division)
--Windows Mobile 7 (strong early momentum with a partnership with mobile phone maker Nokia (NYSE:NOK))
--Microsoft Office 360
--Windows 8
--Skype partnership with Facebook

Impressive Moat:

Microsoft offers an incredible moat through its practical OS-monopoly, Office domination, enterprise entrenchment, strong mobile development, impressive video game platform and strong intellectual property.

Microsoft has a world-renowned team of patent lawyers that defend its IP.

In comparison to Google (NASDAQ:GOOG), which attains more than 90% of its revenue from ads and in comparison to Apple (NASDAQ:AAPL), which attains the majority of its profit from 3 products (iPhone, iPad, iMac), Microsoft has a much stronger recipe for sustainability. It should be noted that the iPod, which was Apple's first game-changer, is now witnessing decreasing sales of 20% annually (according to last week's quarterly results).

Skype Acquisition (speculative):

At first take, Skype was seen as a desperate move by Microsoft to find a use for its large cash hoard. At a purchase price of $8B, which represented a significant premium over the $3.1B paid by eBay (NASDAQ:EBAY), there have been many naysayers due to Skype's lack of profit over its lifetime.

However, if an investor looks past the Skype play as a subsidiary and instead focuses on product integration, a much stronger case can be made. Skype has some of the world's best video codecs and is integrated with international landline calling plans. In addition, Skype has over 550 million registered users, of which 170 million are monthly active. If these codecs can be seamlessly implemented into Office, Windows Live, and Xbox Live, this will represent a huge cost-savings in R&D as well as in possible IP litigations.

The 550 million users represent a strong base to promote online ad revenue (Skype has been very weak in this area), as well as a method to cross-channel users to Microsoft sites and products. With an $8B purchase price (assuming Skype's IP and other synergy is worthless), this represents a customer acquisition cost of $14.55 which is much lower than most services.

The internet ad revenue market is huge - Google alone is expected to have nearly $40B in yearly revenue from this market ($9B recently reported in 2Q11). If Skype's deal with Facebook can enable Microsoft to leverage even a small % of online ad revenue back from Google, the deal will soon be accretive to both revenues and bottom-line profit.

Facebook's deal with Microsoft (for Skype) represents yet another head-to-head battle between MSFT and GOOG. Although Microsoft's track record has not been amazing (most notably with IE and search engine technology), vast improvements have been made. If the Facebook deal can extend to Bing, Google+ could be cut off "at the pass," and MSFT could wrestle a substantial percentage of ad revenues back.

In the end, it will be difficult to know if Skype was truly worth $8B for at least another 3 years. It is important for investors to focus on MSFT's proven 10-year record of 15.1% annualized EPS growth while also understanding that the Skype deal accounted for only 16.3% of Microsoft's net cash.


After a thorough examination of Microsoft's transition during the last 11 years under Ballmer's leadership, it is clear from a long-term investment perspective that Microsoft has dramatically improved as a business and especially as a potential investment.

Although Microsoft does not currently enjoy the positive market sentiment of Apple, Google, or IBM - when compared to similar blue-chip players with a strong moat, MSFT is a clear winner.

Microsoft is currently trading ($27.50) at an Ex-Cash P/E of 7.88. If you don't trust MSFT with its cash pile, than the straight P/E is 10.22. The ex-cash trailing 10yr PEG ratio of MSFT (my personal valuation favorite) is a shocking 0.52.

While the rest of the investment world treats Ballmer with scorn, you can now cite his strong track record of corporate performance and rest safely with a man who truly "loves his job:"

Disclosure: I am long MSFT, NOK.