Declaring that this is the year Microsoft(MSFT) will finally move up sharply is kind of like declaring that this is the
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year the Cubs will win the World Series- only more futile. Though it has moved up considerably from its March 2009 low of $15.28, at $28.12, it’s barely above its price in September 1998- the month Google(GOOG) incorporated. In the intervening 14 years, Google has reached a market capitalization above $200 billion. Meanwhile Microsoft increased annual revenue from $14.484 billion to $69.943 billion, net income from $4.490 billion to $23.150 billion, and has accumulated a cash horde of $52.772 billion while paying out an increasing dividend. Certainly, Microsoft was overvalued in 1998, but today, it remains severely undervalued.
There’s been much talk about a “Steve Ballmer discount” amid critiques of his leadership. Certainly there have been product missteps(Zune, Kin, etc.) and questionable M&A(Skype, Yahoo offer), but he has presided over an era of extraordinary growth nonetheless. There is a meme regarded as truth that Apple and Google are inherently more innovative and will disrupt Microsoft’s business. If Microsoft’s business has been disrupted, nobody has bothered to tell its financial performance. Certainly, the world is changing, but in an iterative way. This is not the sort of transition that felled Kodak, from chemicals to digital technology. Microsoft is not a one-trick pony, and its products are core to a wide variety of markets and niches.
Advocating for Microsoft is not a position we would have envisioned ever taking back in 1998. We were Linux geeks through and through(if you ever want to anger your wife, try to get her to use Linux as her desktop OS). But perhaps we’ve mellowed with age, perhaps the world has changed, perhaps Microsoft has changed.
Analysts estimate that Microsoft will earn $2.72 this year and $3.01 next. Assuming a multiple of 10 and adding $5 of cash and short term investments per share, we get a fair value of $32 – $35. But we believe there are positive trends in Microsoft’s business that will allow them to exceed estimates. The integration of Skype and the launch of Windows 8 and Windows Mobile 8, which have received positive reviews, should spur growth with increasing adoption. The Xbox continues to perform well, led by the unique Kinect user input device.
And then there’s the little surprise called online. For as long as we can remember, Microsoft’s online division has been a disaster. They have consistently spent $2 for every $1 in revenue, and unlike the government, they can’t print money. This quarter the revenue grew dramatically and costs shrunk even more, leading to a much smaller loss on a bigger business. One point does not make a trend, but this is the first glimmer of hope we’ve seen in Online in quite some time. Ultimately, if Microsoft can get there, this business should feature Google-like margins and contribute meaningfully to the bottom line.
Microsoft may remain boring longer than you can remain interested, but we feel it offers a compelling value with a healthy dividend to pay you while you wait.
Disclosure: The author holds no position in any stock mentioned.
Related articles
- Microsoft posts record Q2 2012 revenue, despite Windows division decline (theverge.com)
- This is the year Microsoft fights back (mobilitycloud.wordpress.com)
- In a year full of promise (and risk), Microsoft starts it off with a thud (liveside.net)
- Steve Ballmer: Very rich and very much in love with Microsoft (news.cnet.com)
- Microsoft in 2012: Hopes rest on Windows 8 (infoworld.com)
- Xbox Fuels Microsoft’s Revenue Engine (thestreet.com)
