A Few Thoughts on Microsoft’s Past and Future
The Ballmer departure (which I approve of) led me to run a quick-and-dirty on its free cash flow, and to some general thoughts on Ballmer’s departure.
First, as you can see here, even after today’s bump (to $34.75/share) Microsoft is priced never to grow free cash flow again, and in fact for it to gently decline. An alternative explanation of the pricing is that free cash flow may fluctuate somewhat, up and down, but ultimately decline. Note that the model simply deletes 35% of the value of Microsoft’s $77.022 billion in cash on hand. This is to account for taxation on eventual repatriation of foreign earnings, and/or inflation for holding the cash too long, and/or money wasted on things like Surface or Skype. Note that the model also assumes a constant future figure for diluted shares outstanding, even though that figure has been declining steadily, which is cash-flow-per-share accretive. (The figures are all from the June 2013 report.)
So the question really is whether you believe that is Microsoft’s future or not. In valuing a company, the numbers only are useful to help frame your qualitative and strategic thinking. The English Major side of investing is much more important than the mathematical side, unless you are writing trading algorithms. I continue to think Microsoft can manage some modest growth, and thus the stock is by definition undervalued. I may be wrong, and I’ll say it when I determine that I am. If it happens, it will be a judgmental error, not a math one. In any event my money is where my mouth is; it’s one of my top two stock positions, and is about 8% of my portfolio (much of which is admittedly invested in S&P, Emerging Markets, and European ETFs at the moment). But my desire to be in Emerging Markets and European ETF’s right now is a post for another day.
Now to Ballmer. Contrary to what some are saying, the initially euphoric market reaction to his departure has no relationship to a belief that someone else will be able to staunch the bleeding in Windows, for example. No one can. That is structural. Rather, this reaction is about Microsoft’s inability to innovate in new areas under Ballmer’s tenure. This is about his mockery of iPhones when they came out, his blundering with tablets, his statement that he wouldn’t even let his kids touch the products of “those” other companies. This is about the fact that a Surface tablet glitched up at its debut presentation, and that it was wildly overpriced from the get-go — and everyone knew it (except Microsoft, apparently).
The future of Microsoft, if there is one, is in new product and software categories. The company has to think of something new, like Xbox was new, and it has to make money (unlike with Surface). Microsoft has to take risks. The market simply thinks that such a future is more likely to exist without Ballmer: nothing more. There is good reason for such a conclusion, given Ballmer’s generally abysmal record of innovation, even if there are no guarantees as to the future CEO. A solid, diligent ‘caretaker’ CEO like Ballmer is never a recipe for strong growth, but it is a recipe for disaster in the tech industry. The world simply moves too quickly. IBM was selling its laptop business to Lenovo in 2004. Zuckerberg was creating Facebook. Apple expanded the iTunes music store internationally. Google had its IPO that year. Ballmer was working on Windows Vista. Enough said.