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Bullish on Microsoft

February 03, 2011 | About:
bjm1625

bjm1625

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For those of us that use a computer, for business or personal use, this company needs no introduction. Microsoft (Nasdaq: MSFT), generates earnings through the development, manufacturing, licensing, and supporting a wide range of computer software products, such as its wildly successful Windows operating system and Microsoft Office. Microsoft also designs and sales the gaming system Xbox 360 and its accessories. It currently operates in 5 business divisions: Windows, Server and Tools, Online Services, Business, and Entertainment and Devices.

Strengths

Management

Although not considered to be the visionary like his predecessor Bill Gates, Steve Ballmer, who has been with Microsoft since 1980, and his staff have done an masterful job of consistently growing revenue, operating income, and net income in recent years. Management has also been able to have a strong return on equity of roughly 42% all while facing tough economic conditions and ever increasing competition from the likes of Google and Apple.

On top of the steady growth and high return on equity, Microsoft has also repurchased $170 Million in stock and are authorized to continue a $40 million buyback until 2013.

Products

Along with strong management, you have to look at Microsoft's product line. The Kinect, the motion game sensor for Xbox 360, sold 8 million units in 60 days. Demand will surely continue to be steady for Kinect as those who missed out at on the product during Christmas rush begin to get them in the upcoming months. Alongside the Kinect, Microsoft Office 2010 became the fastest selling version of Office in history and helped the the Business division revenue grow 24% year over year.

Windows has also recently released the windows phone 7 operating system in 30 countries through 60 operators and 9 different devices.

Weakness

The main weakness for Microsoft is the competition they face. This competition from Google, Apple and other software developers will effect the ability of Microsoft to provide future returns on equity as high as seen in previous years and also will slowdown growth prospects and profit margins.

Opportunities

The move toward cloud computing represents a major opportunity for Microsoft. The move has already begun with the development of Windows Azure and firms such as Pixar animations have shown possible uses of the platform. With the vast amount of cash reserves and a strong research and development department, Microsoft will be able to enter the area and quickly gain market share.

Threats

There will continue to be threats from Google and Apple in many areas in which Microsoft operates such as online search, cellular handeset operating system.

Valuation

Using Discounted Cash Flows with a 14 % growth rate (average of past 10 years) in the next 5 years, Microsoft has a fair value of $36.01 which is a 22% margin of safety from Wed. closing price of 27.94.

Investment Analysis

While not the superior growth machine it once was, Microsoft is still a company with solid growth, and strong and shareholder friendly management. With $41 billion in cash and cash equivalent it can still be seen as the 800 puond gorilla in the software space.

Blog is http://newvalueinvestment.blogspot.com/

Rating: 3.4/5 (14 votes)

Comments

Toddius
Toddius - 3 years ago
It's harder to grow at 14% for the next 10 years than it was for the last 10. As size increases, the growth rate is likely to decrease. I think I would choose a more conservative growth rate - probably around 10%.

MSFT has a lot of irons in the fire. If a couple of them pan out they will be well positioned. If Bing starts making money instead of losing it, for instance, watch out.
Alex Morris
Alex Morris - 3 years ago
Good article bjm. Just to note, some of the figures in millions are billions; doesn't change the concepts, just to clarify.
energywonk
Energywonk - 3 years ago
the amount of articles i read trying to justify microsoft as a good investment is mind boggling. yet the answer is right in front of us. does anyone use windows phones anymore? look at their continually shrinking market share. computers are moving to the pocket and microsoft has well and truly missed the boat. gates was brilliant, but msft is as poor investment as you could make, and certainly not a value stock with margin of safety. can i request a ban on articles about msft please?
Toddius
Toddius - 3 years ago
That's exactly why you can buy it so cheaply in relation to its earnings. MSFT has value besides consumer products. It's diversified across operating systems, search, gaming, and now phones. It's also sitting on a pile of cash that it can use to fuel growth or make strategic investments. Don't count them out yet. Remember when Apple was down for the count?

MSFT being out of favor is what has so many value investors looking at it.
superguru
Superguru - 3 years ago
At some point MSFT will be down in dumps and it will need its own Gerstner (IBM) to pull it back.

Does not look like Ballmer is that Gerstner. Though Ballmer, no doubt, is an exceptional business leader but that crises in MSFT is not there.

It is funny, Gates wanted MSFT to avoid the IBM's fate of 1990s, but does not look like MSFT would be able to avoid that.

MSFT, probably undervalued, is still not in that bargain bin.
jonmonsea
Jonmonsea premium member - 3 years ago
Is MSFT is selling for less than 10x next year's earning net of cash and it grows at 8% per year for the next five years while issuing debt at artificially low interest rates to buy back stock, is it not very likely to outperform the S&P?
jonmonsea
Jonmonsea premium member - 3 years ago


Is MSFT is selling for less than 10x next year's earning net of cash and it grows at 8% per year for the next five years while issuing debt at artificially low interest rates to buy back stock, is it not very likely to outperform the S&P?


In response to energywonk's

the amount of articles i read trying to justify microsoft as a good investment is mind boggling. yet the answer is right in front of us. does anyone use windows phones anymore? look at their continually shrinking market share. computers are moving to the pocket and microsoft has well and truly missed the boat. gates was brilliant, but msft is as poor investment as you could make, and certainly not a value stock with margin of safety. can i request a ban on articles about msft please?
jameshou
Jameshou premium member - 3 years ago


Einhorn, Grantham and Yacktman are all long MSFT. Enough said!
energywonk
Energywonk - 3 years ago
its not enought said. lets not forget that our jedi master never buys tech for this reason. in the 80s and 90s tech paradigms were around a decade or more. now as things go mobile i thing that paradigm is more like 5 years. which means apple has around 2 years left before android takes over. and i am sure we have all read the headlines about android becoming largest mobile operating system as apples and everyone elses share shrinks. i understand that msft is showing characteristics of a value stock. good cashflow (for now), seemingly large moats in existing markets. but lets revisit in 5 years. i bet everyone is using honeycomb or something else on their home desktops, enterprise is moving away from msft etc. its ironic that windows 7 mobile and desktop is actually msfts first decent operating system but its too late. you guys can all go long, i will short it, and yep i love einhorn, and grantham too, but they are wrong in this instance. dead wrong.
Kenster
Kenster - 3 years ago


In addition to those 3 value investors, Whitney Tilson last year also made a case for MSFT and First Eagle and IVA fund managers also have it in their top 10 holdings.

MSFT is much more than just a Windows desktop company and that's the narrow issue that many are focused on. As mentioned in the opening post - Office 2010 has been hugely popular and growing as people who are still using Office 2003 and ready to leap over 2007 version and directly to 2010.

Toyota, 3M and Lockheed Martin also signed with Microsoft for their cloud services. (Azure) And frankly, MSFT has the scalability to handle it. Their BPOS cloud-services where Exchange and Sharepoint are hosted in the cloud has been making tremendous headways especially with small-mid size firms sick and tired of managing these on-premise Server solutions that get more complicated. This will be rebranded as Office365 later this year.

Let's take a look further as to what Microsoft offers besides the Windows desktop OS and Office:

- Forefront Threat Management Gateway (TMG)

- Forefront Unified Access Gateway (UAG)

- Forefront End Point Protection (FEP)

- Exchange

- SQL Server

- BizTalk Server / Host Integration Server

- System Center Config Manager

- System Center Ops Manager

- System Center Service Manager

- System Center Virtual Machine Manager

- System Center Data Protection Manager

- Opalis (new acquisition)

- Avicode (new acquisition)

- SharePoint - extremely popular and growing the past few years and in fact I know of many small-mid consulting firms that focused a part of their core business around SharePoint consulting services.

- Visual Studio

- Expression

- Project Server

- Lync (which is the new OCS)

- Dynamics / CRM - CRM 2011 Online in the cloud

- Intune - new cloud based service coming in the spring and has been in the news

- MapPoint

- Bing Maps - see www.microsoft.com/maps/gallery for examples of how some orgs are using Bing Map for integration into their location services or apps.

Vista was a disaster the past few years (5 or so) but the MSFT has been able to hold up well with a huge cash bucket because of their diverse reach into different technology areas as listed above.

Further, Microsoft and Citrix have a strong alliance and created something they branded as V Alliance (v-alliance.net) to provide joint and collaborative solutions around Client Virtualization. A lot of Ctirx solutions that companies are using today also require Microsoft licensing.

VMware Server virtualization has been a hot topic but VMware only provides the Hyper-Visor --- they do not provide the Server OS and that's where Microsoft comes in.

So as you can see, people can mistakenly believe that Microsoft is just a Windows desktop company. And that can be understandable because most people don't see the "behind the scenes" action when these technologies are running in the background or in the datacenter such as SQL Server and Exchange Server which are hugely popular. How many people know that when a large hospital or organization is using Citrix's Xenapp solution for session/app access that that relies on Microsoft's Terminal Services? Not many people know that.

energywonk
Energywonk - 3 years ago
kenster good analysis. but bing maps. had to laugh at that one. besides that a good overview. im still shorting it though
Kenster
Kenster - 3 years ago


What's so funny about Bing maps? Can you clarify? You can use it for free but with restrictions, otherwise you'll have to license it to break free of the restrictions or say you wanted it feed an internal app for asset tracking for your goods or fleet of vehicles. Also, I believe you need to license to get additional features from Bing's Map Platform for birdeye's imagery view.

It looks like some commercial and government customers are using the Bing Map Platform such as BofA, Barclays, Expedia, Marriott, Toyota, Ford, Starbucks, FedEx, European Environmental Agency, etc, etc.

Check out these few sites that rely on the Bing Maps Platform.

http://eyeonearth.cloudapp.net/

http://www.cbcworldwide.com/home.html

http://www.ix-m.com/pelican-racing/

http://mapmyclimate.dk/mmc/?referer=dr.dk&action=climateeffects

What you're also failing to realize is that some of these organizations that rely on the integration of location-data from the Bing Maps Platform for their applications are also using Microsoft Azure cloud-services to host these apps. You may also want/need SQL Server or Sharepoint integration. Or maybe you want a Bing Map Platform to integrate with Microsoft's CRM solution to get a visual mapping of where your customer base lies around the country. These solutions cost money and goes to Microsoft's pocket.

Case in point and this is public info out there --- a consulting firm helped out a Government agency in Southern California/San Diego put together a mapping solution to deal with monitoring major wild fires which they faced in 2007. The Consulting firm were tasked to build an Emergency Management Platform to give incredible view of the terrain. Oh so what technologies were involved? Microsoft SharePoint Server 2007, Virtual Earth (Now Bing Maps Enterprise), InfoPath 2007, SQL Server, Live Communications Server. So they were able to overlay thermal imagery from NASA with Microsoft's mapping to provide critical visual data of the wild fires.

Dept of Ohio uses it too for traffic monitoring:

http://www.buckeyetraffic.org/

City of Miami is also licensing Bing Maps Enterprise as well --- and in addition they hosted their app on Microsoft's Azure cloud service and also using Visual Studio and Microsoft's .NET Framework.

So when I hear people say that Microsoft isn't going anywhere because Vista sucks and Windows 7 is good but late to the game --- I would like to hear a much better and thorough "short the stock" evaluation because there is so much more going on at MSFT than just the desktop OS. And it's true that MSFT has been very late to the game with Smartphones and behind everyone else (Apple, Google) with coming out with a Win 7 based TouchPad device but I don't think that's a "short the stock" story especially based on all I mentioned aabove about how huge their business is outside of Windows 7. And frankly on desktops/laptops --- you still have something like 80% of orgranizations I think that still need to migrate from XP to Windows 7.

Mac popularity has creeped up but not a major dent especially in businesses and government which will still be overwhelmingly Windows-based PC's. I know of a major arts-oriented college that uses all Mac machines for their students but also uses Windows 7 in a dual-boot scenario.

I'm not saying MSFT stock has major growth potential like what happened with Apple stock but I can definitely see it being undervalued right now like a number of the other value managers and I definitely don't see a short-the-stock story behind it.

superguru
Superguru - 3 years ago
deleted
radamus
Radamus - 3 years ago
This is just a supplement of sorts to Kenster's excellent post. The terms "cloud" or "cloud computing" are just easy to remember buzz words to describe a new phase in the evolution of the various information related technologies. This trend might be described as "an increasingly intelligent, flexible and secure distribution of information capture, presentation, transmission, storage, and processing". To varying degrees most of the things Kenster listed are performing functions that will be critical in any end-to-end implementation of a "cloud solution". Kenster's list doesn't include(unless I'm not recognizing the term he's using) some other important Microsoft cutting edge initiatives including whitespace implementations, mobile high end wireless application routers, and some less obvious but equally critical products like bing(and related products and services) xbox, x-box live, kinect, zune, and windows phone 7. Most of these things have been money LOSERS for MSFT for years but MSFT still managed to grow revenue and earnings in the 10% range during that time period. I doubt if any of these products will rival Windows and Office in money making power, but I certainly expect them to be money makers instead of loser within the next 3-5 years.
grandpagates
Grandpagates - 3 years ago


Today's WSJ has a headline "Tablets Sapping Demand for PCs".

It's a headline that tells people what they want to hear.

It goes on to say that Gartner expects PC shipments worldwide to bo up 10.5% in 2011, though admittedly, the growth is primarily overseas, where I believe MSFT charges less for a license.

Still, this all reinforces the popular conception that PCs are dead, causing the MSFT share price to go down.

shulink
Shulink - 3 years ago
I'm pretty bearish on Microsoft. They are lack of innovative idea and products. Google and Apple are better stocks to buy for the long term I believe.

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