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Two Important Additions For Microsoft

February 10, 2014 | About:
The Science of Hitting

The Science of Hitting

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Well, Microsoft (MSFT) finally named a CEO; as this story has progressed, I’ve come to learn that time is a key factor upon which market participants judge the outcome of the selection process - and that once we start talking about months instead of weeks, they start to get antsy.

Thankfully, we’re past that point – a CEO has been named, and the next round of speculation can begin. While many have clung to what I believe are seemingly unfounded generalizations about Mr. Nadella, people who have actually worked with him are talking as well – and they’ve got some interesting things to share. An example of the former is the constant reference to Mr. Nadella as a “safe” candidate. To CNN Money, that means “he is not a corporate visionary… and may not shake things up too much at Microsoft.” To Yahoo Finance, that means “staid continuity”. Plenty of others have reasons why he’s “safe” – there’s just not much to sink your teeth into as to why they’ve drawn that conclusion (beyond the elementary idea that anybody picked from inside the company is “safe”).

But let’s stop with meaningless adjectives and look at some important numbers. Consider the performance of Server & Tools over the past few years: sales have nearly doubled in six years through the heart of the worst recession since the Great Depression, and Microsoft has taken share from key competitors; operating income increased at an even faster rate than sales, and accounted for 25% of the company’s total in 2013 (just shy of Windows). That’s where Mr. Nadella has been in charge the past three years; if that’s your definition of “safe”, I’m all for it.

I’ve read just about every article I can find on Satya Nadella, and much of it does not mesh with what I've heard from the financial media (or at least the big sources in the US). If you’ve also done a lot of your own research, this article isn’t going to be of much use; but if you’re a Microsoft investor / follower that hasn’t taken a close look at Mr. Nadella, here’s a few things that you might be interested to hear:

He is the anti-Ballmer – According to Richard Waters of the Financial Times, that’s the observation of almost everyone who knows Mr. Nadella. John Connors, a former senior exec at Microsoft, said “he’s a cerebral guy, not a pound-the-table kind of guy.” This gets to the core of a glaring problem at under Ballmer, at least in a few areas - a failure to recognize and adapt to change; in my mind that largely came from a false sense of certainty in an uncertain world.

One obviously example comes from mobile; Steve Ballmer laughed at the iPhone when it was introduced (this is after Microsoft was already smoked by the iPod), saying that “there’s no chance that the iPhone is going to get any significant market share - no chance.” In 2007, the year the iPhone was introduced, Windows Mobile had 42% market share, about four times larger than iOS (per NPD data); by 2010, iOS had doubled its market share to more than 20%, with Windows down to single digits. What Steve viewed as impossible was reality three years later.

Compare this to what Mr. Nadella said about himself in his introductory email to Microsoft employees: “Many who know me say I am defined by my curiosity and thirst for learning. I buy more books than I can finish. I sign up for more online courses than I can complete. I fundamentally believe that if you are not learning new things, you stop doing great and useful things.”

Doug Burgum, who sold his business-software development company Great Plains to Microsoft in 2001 and was Nadella’s manager for a few years, echoed these comments: “He’s really the complete package - he has incredible intellect but he also combines that with a deep curiosity and willingness to learn.”

Nadella helped build Microsoft's search business, and surely understands just how devastating Google’s commanding lead has been in trying to scale Bing. As he said in his memo to employees, “our industry does not respect tradition — it only respects innovation.” I think Nadella is more grounded than his predecessor – and I think that’s a critically important characteristic for the next leader of Microsoft to have.

He realizes the world doesn’t revolve around Redmond – At BUILD last summer (annual developer conference), Nadella famously pulled out a Mac to build an iPhone app in front of 6,000 developers; he wanted to make the point that Azure could be utilized for iPhone & iPad apps. As noted in a Business Insider article at the time, “he wanted to show how Microsoft's cloud, Azure, would be a great choice for programmers, even if the apps they built were not aimed at Microsoft's Windows or Windows Phone operating systems.” Here’s what Rakesh Malhotra, a 10-year Microsoft veteran, said about that event: “He did the demo off a MacBook in Silicon Valley. That seems like a totally normal thing for people to do, but at Microsoft, there's no way you could think about doing that… it got a bunch of headlines because no one at Microsoft had ever done that before.” It’s encouraging to know that Mr. Nadella refused to keep his head in the sand and stick to what would be considered “safe” by people in Redmond; he was unwilling to deny the reality in the world around him – a point of view that will be critical in setting Microsoft’s vision for the coming decade and beyond.

He is no-nonsense – While captured in the previous point, this warrants further discussion. Mark Chweh, co-founder and CTO at SweetLabs, said the following: “Satya is a no-nonsense technologist with a reputation for unvarnished evaluation of situations and a no-bullshit policy. This is the guy you need to actually build the Microsoft vision.” That commentary meshes with what you will find in most articles about Mr. Nadella; as an investor, it is music to my ears. One can only hope that this extends to capital allocation – which brings me to my final point…

The icing on the cake – While much of the attention has fallen to Mr. Nadella, I’m still firmly focused on another individual who is moving into a big role at Microsoft – a gentleman named Mason Morfit. If you don’t know who he is, maybe this will help – Mason is the President of ValueAct Capital, where he’s been since 2001. Value Act took a $2 billion stake in Microsoft in April 2013; four months later, the company inked a deal with Microsoft to have Mr. Morfit join the board, a sign that Microsoft was receptive to hearing what a respected outside investor had to say.

For the most part, that’s all we’ve heard from Value Act; they tend to work with the board in a constructive manner behind closed doors rather than engaging in a public skirmish (it may not get as much attention, but can be quite fruitful – for example, take a look at Valeant Pharmaceuticals – VRX - in the three and half years since Morfit joined the board). One of the few public commentaries we’ve heard from the firm came a few weeks after their stake in MSFT was revealed; Jeff Ubben (Trades, Portfolio), the CEO and CIO of Value Act, stated at a conference that over the ensuing three to five years, “Microsoft could be the largest cloud company in the world.” One person comes to mind as the clear choice to get Microsoft there in the coming years – Satya Nadella (on a side note, the company’s Commercial Cloud division reported revenues in the first half that were double the prior year’s tally).

This article from David Kirpatrick of Forbes (here), outlining a conversation the author had with Mr. Nadella over lunch last November, suggests a similar viewpoint from the new CEO ("In one word, the answer is 'cloud'"). Mr. Morfit recently made the following congratulatory statement to Satya:

“I am very enthusiastic about Satya Nadella’s appointment as CEO of Microsoft. As an active contributor to the CEO search process, I have spent a lot of time with Satya and he is clearly the best choice to lead the company. I look forward to working with Satya, Chairman John Thompson and the rest of the Board of Directors to create value for all shareholders.”

If you haven’t figured it out by now, I share Mr. Morfit’s enthusiasm – I think Mr. Nadella was a great choice for the CEO position. Microsoft is a significant position in my portfolio; with the news of Mr. Nadella’s appointment, that will not be changing anytime soon.

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

Rating: 4.9/5 (22 votes)

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Comments

The Science of Hitting
The Science of Hitting premium member - 6 months ago

Beltrancaceres - Nadella's memo is certainly worth reading; thanks for the link and the kind words!

vgm
Vgm - 6 months ago

Very insightful piece, Science. Thanks!

As a potential cherry atop the icing....you may have noticed that Steve Mandel (Trades, Portfolio) at Lone Pine took a large (25.5M shares) position in MSFT in Q4 according to the latest filings. A positive omen. He's arguably the best out there.

The Science of Hitting
The Science of Hitting premium member - 6 months ago

Vgm - No, I did not see that update from Mandel; thanks for letting me know about that! So it went from zero to his fourth largest position in Q4 alone? Very interesting - in addition, he appears to be a big investor in VRX, so he is likely quite familiar with Value Act. Thanks for the comment Vgm!

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