Microsoft Investors: Still Carrying Dead Weight

Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

At the risk of stating the obvious, Microsoft (NASDAQ: MSFT) is no longer a sexy company. It’s also no secret that Wall Street would feel better about its prospect if it were under new leadership. But let’s not hold our breath on Ballmer getting the ax any time soon. If it were ever going to happen, it would have happened already. Still, something needs to be done.

Making matters worse, hated rivals Apple (NASDAQ: AAPL) and Google (NASDAQ: GOOG) dominate everything. This places a huge spotlight on “Mr. Softy’s” failures in the mobile devices market. The company can't escape. But, that doesn’t mean Microsoft lacks value. Still, unless things fundamentally change, the company just might become “dead money” for the foreseeable future.

Failing Franchise: Windows 8 & Surface, Early Busts

It says a lot when a disappointment from a tech bellwether barely moves the needle.  In the company’s first-quarter fiscal year 2013 earnings results, Microsoft disappointed the Street by reporting net income of $4.47 billion or $0.53 per share on revenues of $16.01 billion. But no one really cared.

The company missed both top and bottom line estimates of $18.11 billion and $0.65 per share, respectively. The drop of 8% in revenue ended its streak of revenue growth, which spanned four quarters, while EPS also declined by 22%.

However, here’s the scary part – the company’s Windows division took a huge hit, posting $3.2 billion in revenue. While that might sound like a lot, it represents a year-over-year drop of 33%. It’s disappointing today, but evidence suggests that things are only going to get worse. Why?

Although PC shipments dropped in the Q1 by 8.6%, numbers from Microsoft’s OEMs such as Dell, Hewlett-Packard and Intel suggest that the percentage might reach the high teens by the second half of 2013. The company’s life is flashing before its eyes and Microsoft needs to prove to investors that it understands the future of computing.

Microsoft’s response was to enter the tablet market with its own in-house built hardware called Surface. Although it was a step in the right direction, the Street has not cared for it and the reception for Windows 8 has been abysmal – prompting several the Street to cut estimates. Recently, analyst David Hilal of FBR offered this in a research note:

“While the anticipation and launch of Microsoft’s Windows 8 operating system has been one of the most talked about technology stories of 2012, we believe initial adoption of the OS and sales of Microsoft’s first tablet have been disappointing.”

Growth Today, Gone Tomorrow – Buy Time

Granted the company had little choice – its hands were tied.  The success of Apple and Google coupled with the presumed death of the PC industry made entering the tablet market an easy decision. However, in the process the company alienated several partners including Dell and HP.

Unfortunately, it now seems that it was all for nothing -- consumers don’t want it, at least not to the extent that Microsoft had hoped. Google’s Nexus 7 tablet and Amazon’s (NASDAQ: AMZN) Kindle Fire are both rated higher than Surface. This is despite the fact that Amazon takes a loss on each tablet sold while Google only breaks even.

Their respective models care very little about profiting from tablets - rather, it's a content source. For Microsoft, it's more than that. It's respectability. Unfortunately, it's not progressing quite as planned. And if the competition has anything to say about it, it's not going to get any better. 

Essentially, as Microsoft’s Windows franchise is suddenly beginning to take a hit, the company’s entrance into new growth areas is being slowed, if not maliciously thwarted by the competition. So from where is the company’s future growth and profitability going to come? I think the company understands this position. I just don’t agree with its response.

Microsoft recently decided it was time to raise its quarterly dividend from 20 to 23 cents. Essentially, the company is saying that it has no better use of its capital or no more “neat ideas” left. Microsoft knows that it is struggling to compete. However, offering a new yield of 3.1% can entice investors to be patient while preventing mass share selloffs. It’s brilliant. But how long will it work?

Bottom Line

Microsoft is smart enough to have bought itself some more time. And the good news is, the company’s cash position and balance sheet offers very limited downside risk. But until something fundamentally changes with the company, I just don’t see why anyone would be compelled to place a bet here. Dividend income investors might have been given new motivation. Growth and value investors should look elsewhere.


rsaintvilus is long AAPL and has no positions in the other stocks mentioned above. The Motley Fool owns shares of Apple, Amazon.com, Google, and Microsoft. Motley Fool newsletter services recommend Apple, Amazon.com, Google, and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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