Why won't Wall Street give Microsoft a break?
Betanews reader Robert Johnson wants to know the answer to the question, which he asked me on Friday night. His short e-mail "I'm Confused About Microsoft" got me to reflecting again about Microsoft's performance under Steve Ballmer's executive leadership and the stock's moribund consistently sub-$30 over the last 10 years. Microsoft is a hugely profitable company that likely will be for many years, so why won't industry and Wall Street analysts and investors give Microsoft a break?
Before getting to Johnson's e-mail and my response to it, some context: Ballmer ascended to the chief executive's position in January 2000. In October of that year, Microsoft announced fiscal 2001 first quarter income of $2.58 billion from $5.8 billion revenue. An accounting change affected earnings, which were 46 cents a share without it and 40 cents a share with it. By comparison, for fiscal 2010 first quarter, Microsoft reported operating income of $7.12 billion and net income of $5.41 billion, or 62 cents a share, from $16.2 billion revenue. Assuming income in the past means "operating," Microsoft's percentage of income derived from revenue is statistically equivalent for the recent quarter and the one 10 years ago.
Some more context-setting statistics: For fiscal 2002, ended June 30, 2001, Ballmer's first full operational year as CEO, Microsoft reported operating income of $11.72 billion, or $1.32 earnings per share, from $25.3 billion revenue. For fiscal 2010, Microsoft reported operational income of $24.1 billion and net income of $18.76 billion, or $2.10 earnings per share, from $62.48 billion revenue. Over nine years, Microsoft's revenue increased by nearly 2.5 times. Income grew by less. Again, assuming Microsoft's past income means operational, income as percentage derived from income declined to 38.5 percent from 46 percent.
On Nov. 2, 2001, Microsoft shares sold for $30.70. The stock reached $34 a share two months later. Microsoft shares stayed below $30 a share until January 2006, before falling to $22 a share six months later (During this time period Microsoft announced that Windows Vista wouldn't ship for Holiday 2006). Shares again rose about $30 in January 2007, right before Microsoft publicly released Office 2007 and Windows Vista. The stock rallied to $37.06 on Nov. 2, 2007. By mid March 2009, the stock had fallen to $16.65 a share. During 2010, Microsoft's share chart looks like a roller coaster ride, repeatedly rising above $30 and falling far below it. Microsoft closed at $26.85 on Friday. Is there a disconnect between Microsoft's share price and performance, which is consistently good over the past decade?
Johnson and Wilcox exchange E-mails
Johnson's e-mail starts with the "I'm confused" subject line and continues:
- PC's have seen an increase in sales.
- Windows 7 is the fastest selling OS in history.
- Office 2010 is the fasting selling consumer version of office.
- MS raised its Kinect sales forecast from 2 million to 5 million for the holiday season.
- XBOX Live is a new billion dollar business for Microsoft.
- XBOX 360 is now the #1 selling console.
- Windows Phone 7 has been getting some very positive reviews.
All of this and analysts at Gartner (?) have MS stock at neutral and the stock price is stagnant? What's wrong with this?
I can explain some of it, Robert,
Simply put: Microsoft isn't really opening up new major markets but sustains on monopolies built during the late 1980s and throughout the 1990s.
PC sales: Mature markets are saturated, meaning OEMs and Microsoft are selling to the same customers. There is rapid growth in emerging markets, but people there are more likely to steal software than to pay for it. More importantly, in most emerging markets, the cell phone and not the PC is often the first Net-connected device people own. It's a phenomenon sometimes described as technology skip.
Windows 7: By all indications, Microsoft isn't gaining new customers but selling to existing ones, and the majority of these run nine year-old Windows XP. Fastest-growing is misleading because: 1) The install base is larger today; 2) There is pent-up demand because of the Vista flop; 3) Sold really means license shipped, not deployed.
Office 2010: By what measure is this claim? I simply don't believe it based on the revenue numbers I see.
Xbox: The console and service generate lots of revenue but low margins. It's not a hugely profitable business and one that, depending on the quarter, loses money.
Windows Phone 7: The mobile landscape has changed. Microsoft has released a 2007-08 vintage operating system, having already lost developer mindshare to Android and iOS.
Please don't take this as a necessarily dismal view, because:
1. Microsoft marketing is sizzling hot, and that's great for generating positive perceptions about the brand and for product sales.
2. Microsoft's strategy of extending its Office-Windows-Windows Server apps stack to the cloud is fundamentally sound for reselling stuff to existing customers. They get benefits of desktop software presumably for lower costs (including upgrades and maintenance) and greater convenience (including instant updates and anytime-anywhere-on anything access).
3. Windows Phone 7 demonstrates how Microsoft can approach a tough competitive market by changing the rules and delivering a forward-thinking user interface.
That's a shortlist.
Many analysts are status quo thinkers. That's one reason so many projections turn out wrong and why so few analysts predict real innovation. Which Gartner or IDC analyst foresaw the changes Apple or Google would bring to mobile five years ago? But I recall reading in 2005 (and I don't have handy sources ready) analyst projections that Windows Mobile 5's Exchange support would crush BlackBerry. Well, that sure as hell didn't happen.
So don't despair, Robert. What do the analysts know more than you? That said, qualifying I'm no financial analyst, it's hard to see after Microsoft delivered such strong revenue growth during the last decade but with fairly stagnant stock prices how the share price can change any time soon.
It's All About Perception
I want to add some things left out in my rush to respond quickly to Johnson. The real measure of a public company's value is perception -- how investors and other people value the company and how much confidence they have in it. That's a seeming simplification. After all, institutional investors (who are in a stock for the long haul) and day traders (who seek the quick profit) are among the many influencers on share price. Then there is the movement of the whole market to consider. But ultimately, a stock's price depends two things: Performance and perception. Microsoft has got performance -- sure it's no longer a major growth company, but there's sustained growth over its lifetime and more recently the last decade.
Fundamentally, Microsoft has a perception problem. I can see why Johnson is "confused," when looking at Microsoft financial performance and recent product and services announcements. Investors have shown little love towards Microsoft for a long time, regardless of performance. It's a vicious cycle: Stagnant shares don't grow because the volume of investors don't see enough potential return, which further holds back shares from growing.
By the numbers -- and, yes, there are many more measures than presented here (like a division-by-division view, among others) -- Microsoft revenue and income performance look pretty good (that's conceding margins are declining). Microsoft is executing tactically, in ways that appeal to the head but not enough to the emotions. For all the talk of numbers and data driving investor decisions, emotions have a huge role -- particularly people's fear of losing money.
I have a question for Steve Ballmer: If investors are going to punish you anyway, why not give them a reason now that later could give them more reason to reward you? Middle-aged Microsoft doesn't take the kind of risks that made it a wunderkind in its youth. Take risks that give investors confidence in Microsoft's can-do spirit -- that the next mind-blowing "Oh, my, God, why didn't I think of that" innovation will come from Redmond, Wash., and not some Silicon Valley-based company like Apple. Blabbering about how many Windows 7 licenses sold doesn't generate confidence. Windows represents Microsoft's past -- and still hugely profitable -- legacy. Steve-o, don't leave loyalists like Johnson confused.
For Betanews readers, I have three questions marginally related to this analysis: What do you think of Steve Ballmer selling $1.3 billion in shares, or about 12 percent of his stake in Microsoft? Does that make you feel any less confident in the company? Timing is interesting, considering where share price was last week. Could it signal Ballmer is on his way out? I leave the answers to you and for debate in comments.