Is MSFT a long-term buy? Let’s take a look
The Softer Side of
Microsoft
Over the next couple of years, there’s a real
possibility of a big — though temporary — jump in Microsoft’s earnings due to
an important release of Office, including improvements to Excel; an up-tick in
Microsoft Business Solutions (MBS) sales once Vista is released, and an up-lift
in the server business driven by companies buying the associated MBS
applications.
But this doesn’t make
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year “buy and hold.” It isn’t.
Excel’s got issues
One theme I’ve been exploring is how inadequate
Excel is for any kind of repetitive, collaborative enterprise-wide task
(budgeting, closing, etc.) If Microsoft had had any kind of competition in the
Office market, it probably would have addressed these limitations years ago.
Instead, many Global 2000 companies have adopted packaged solutions to replace
spreadsheets, or have forced end-users to use business intelligence-powered
tools.
For the past couple of years, third-party vendors
have been using Microsoft DotNET to create solutions with the look and feel of
Excel but which address Excel’s data- and “referential integrity†issues.
Referential integrity is critical in effective
database management systems, yet which, in an Excel spreadsheet, takes an
enormous amount of effort. This has dampened sales of Office / Excel during
recent corporate upgrade cycles.
For example, when you are working by yourself,
Excel’s lack of referential integrity is a “manageable pain in the neck.” But
when you are running, say, a budget through an enterprise, end-users from other
divisions are constantly adding additional lines and columns to the spreadsheet.
Rolling up all these divisions is usually accomplished by, for example, adding
all of the F12 cells into a master F12 cell. If someone had inserted another
line above row 12 (to show a little detail), or inserted another column before
column F, then all the cells in column F on will not add up correctly into the
master cell; neither will all the cells below row 12. This is why some people
who have to manage the process call spreadsheet budgeting “Excel Hell.â€
The solution is for the cells to have referential
integrity. Cell F12 “knows†that it is, for example, April and that the cell’s
contents relate to employees’ Health Benefits expense. No matter how many lines
and rows are added, it still retains that definition.
Potential for growth here
There’s a good chance Microsoft will address the
referential integrity problem in its next big release of Office. If it does a
good job, large corporations and mid-size companies will see real value in
upgrading their Office suites, which means a big payday for Microsoft.
This is a potential catalyst for MSFT; but only
for shorter-term-positions, not the long-term.
I’m not sure where expectations are about how
soon, and how fast, we see a major Office replacement cycle. The above-mentioned
improvements would help create a compelling reason for companies to upgrade to a
new release of Office, which would involve a large proportion of a company’s
Office users since the objective would be to improve enterprise-wide
collaborative processes such as budgeting.
But it all depends on where Street expectations
are for an Office upgrade cycle. If expectations are for a standard upgrade
cycle, or reluctance to up-grade, then a wide-spread upgrade would be a positive
surprise to revenues and good for the stock price.
Not a “buy and holdâ€
MSFT trades at a P/E of 19-times forward earnings
— a discount to both Oracle
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at 23-times earnings. It also trades at a P/S of 8-times forward sales — a
premium to ORCL at 5.3-times, and to BEAS at 3-times.
I consider the MSFT stock price to be a bit rich:
Its discount on a P/E basis is justified, due to some financial maneuverings to
make its recent EPS numbers, and its premium on a P/S basis looks overvalued in
light of its modest, mid-single digit revenue growth.
Last week, the company reported quarterly
revenues of $9.74 billion, up 6% year-over-year. This was $40 million lower than
guidance; yes, it’s a “miss†of only 0.4%, but the trend is still a tad soft.
Expenses for the launch of Microsoft’s new products will be higher than
anticipated — aren’t they always — as it rolls out MS Office 12 and Vista
(formerly Longhorn) during fiscal 2006 (end June 30, 2006), so margins will
probably contract a bit. But the higher expenses didn’t lead to management lower
earnings estimates for the fiscal year 2006 for two reasons: A lower tax rate
and Microsoft accelerating its huge $19 billion share repurchase program, which
is a negative as it means the company employed some financial engineering to
make EPS this quarter.
On the sunnier side, Microsoft continues to be a
cash-flow machine — but that isn’t sufficient to propel the stock price.
Longer-term, the stock’s P/S ratio probably drifts lower: based on mid-single
digit revenue growth, around 6-times sales seems closer to fair value. But this
will take years, since MSFT maintains an artificially high floor — at around
$23 to $24 — since institutional investors continue to own it to get exposure to
the tech sector and income-oriented investors own it for the dividend.
Not a value play, either
Some consider the stock a value play given
Microsoft’s moderate revenue growth and EPS growth in the 12% to 15% range.
A value play? At this valuation?
Is there a dividend yield floor to the stock?
Where are rates headed? I don’t think so.
Are there undervalued assets or a breakup
possibility? Nope.
Could there be another big special dividend?
Certainly, and that’s about the only place where you might think of this as a
value play – because you total return might be a bit higher if they pay a big
dividend and a couple months later the price of the stock is not “price minus
dividend.â€
But mostly you would buy MSFT because it still
has cash / earnings growth potential, and for that the price is OK. But I’ll
pass and look elsewhere.
Melanie Hollands
For 14 years, Melanie Hollands has covered the technology and telecommunications sectors, from positions held in
business strategy (McKinsey & Co., Bain & Co.),
corporate finance (Salomon Smith Barney) and
fundamental equity research (Merrill Lynch). She
follows PC/server/storage hardware, enterprise and
application software, wireless
hardware/software/middleware, data networking and
telecom equipment, optics, semiconductors, semi
capital equipment, and various niche technologies
(RFID, WiMax, VOIP and others).
Hollands is president
of Koala Capital (located in Aspen, Colo., and New
York City), which focuses on trading/investing in
technology stocks. She is also a senior advisory board
member for a start-up financial services venture, the
Semiconductor Futures Exchange Inc., and an advisory
board member for a start-up Linux-HPC venture, Tadpole
Ventures, LLC. She has been a guest lecturer and
adjunct professor at Columbia Business School, where
she earned her MBA, and serves as an advisory member
for various faculty departments. She also holds a
joint bachelor’s in Architecture and Structural
Engineering.