Microsoft’s Q2: Time to Kick Ballmer and PCs to the Curb
Richard is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Say what you want about the word “conviction,” but patience has its limits. Cheering on a company is all well and good. But if it’s not matched by execution, there’s a point when it’s best to cut your losses and move on. Microsoft (NASDAQ: MSFT) serves as a perfect example. While I do believe the stock has value, shares have been stuck in quicksand for some time -- and that’s really the key.
You see, despite Microsoft’s prolonged struggles, there’s a constant threshold. The stock has never fallen to ridiculous (teen) levels. But there’s a first time for everything. And unless the company addresses its poor leadership, shares have a chance of falling below $20. To prevent this, in its Q2 report, Microsoft must respond to concerns about poor Windows 8 and Surface sales.
Low Expectations for Q2
The software giant will announce second quarter earnings on Thursday and expectations are… well, more realistic. Consensus estimates are calling for 75 cents per share on revenue of $21.7 billion. This represents a profit decline of 5% with a modest 4% sales growth.
That both earnings per share and revenue have declined since Microsoft’s Q1 report, the Street isn’t expecting any miracles – especially since the death of the PC, which was once a rumor has been affirmed. Not only did 2012 prove this, but it was evident in Microsoft’s own performance as well as those provided by OEM partners Hewlett-Packard (NYSE: HPQ) and Dell (NASDAQ: DELL).
For that matter, PC sales in 2012 were the worst for the industry in over a decade, including (roughly) -7% in Q4. However, it’s going to get worse. This is hard to imagine considering the software giant’s abysmal Q1 report, during which Microsoft posted net income of $4.47 billion on revenues of $16.01 billion, missing both top and bottom line estimates.
Likewise, Dell reported an 11% year-over-year decline in revenue, which also arrived 5% worse sequentially. For Dell, declines appeared in every segment led by a poor PC performance, which posted an 18% drop. The laptop segment shed 26% year-over-year, while software and peripherals dropped 11%.
Unfortunately, Dell’s recent attempts to offset poor PC sales by buying up software companies have not worked. And there are now rumors that the company is up for sale. While it seems that Dell has all but given up on its PC business, there was a pleasant surprise from Hewlett-Packard, as faint as it may have been.
In HP’s most recent quarter, the company posted revenues of $33.6 billion – exceeding estimates of $33.1 billion. And the company beat profit estimates by 2 cents ($1.16 vs. $1.14). On the other hand, diluted EPS was a loss of $3.49. Although HP beat its revenue target, sales fell almost 7% year-over-year for the fourth consecutive quarter.
Time to Forget PCs, Time For New Leadership
As with Microsoft and Dell, HP has had no answers on how to reverse the decline of PCs, a trend that hit Microsoft pretty hard. Not only did revenues decline by 8%, but the company managed to shed 22% in profits, sending the stock to its 52-week low of $26.26. What once served as strength for the company is now a weakness.
Although Microsoft still owns roughly close to 90% share of the PC operating system market, this highlights the company’s slow response into higher margin growth areas such as the cloud, where rivals Salesforce.com and Oracle (NYSE: ORCL) have dominated. Instead, the company remained focused on its Office and Windows franchises. This strategy has failed.
Unfortunately, management also failed to anticipate the hit Microsoft would take in its Windows division, which posted a 33% decline in revenue. All of this points to one thing – Microsoft must enter a phase where it begins to forget about the PC, which will be the perfect time to replace CEO Steve Ballmer.
Consider this -- as Microsoft is losing its position to nimbler rivals in consumer electronics, the company is also being skipped over in the enterprise by a better managed Oracle. The database giant has been spending its cash on acquisitions such as RightNow and Taleo to help grow its cloud offerings, moves that will allow Oracle to produce better profit margins in the coming quarters.
Also, Oracle’s ability to post 17% growth in its software and subscription business means that the company is already stealing share from Microsoft in software and the cloud. Meanwhile, Microsoft’s management has instead opted to raise its dividend from 20 to 23 cents, which in my opinion is a sign of giving up.
Sadly, the company doesn’t understand that it is being outspent in growth end-markets. And it doesn’t appear to care. And nor does management seem to know how to respond to threats that are all looking to displace the PC as the main business productivity tool.
The company has been too slow to adapt to several key growth areas such as mobile, where Apple and Google have rendered Microsoft irrelevant. Although Microsoft has attempted to launch competing products such as Surface and Windows Phone, sales have been dreadful. And now it’s losing the enterprise too.
What does the company have left? Aside from raising its dividend, there is no compelling reason to hold these shares. And if Microsoft's board was worth anything, they would realize that it’s time for a new direction. Getting rid of Ballmer is worth at least $3 per share, or 10% in premiums. It’s time for the company to do right by investors – for its own sake.
rsaintvilus is long AAPL and has not positions in the other stocks mentioned