"Surface" Tablet Will Drive Growth for Microsoft
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Microsoft (NASDAQ: MSFT) has a new tablet, dubbed the “Surface,” which will debut when it releases its updated Windows 8 operating system later this year. The Surface is aimed directly at a tablet market dominated by Apple (NASDAQ: AAPL) and Samsung. It obviously is not the first time that Microsoft, which has made hundreds of billions of dollars by licensing its software to third party hardware manufacturers, has chosen to compete against these manufacturers. Its Windows operating system, as employed in Nokia's Lumia 900, is a direct challenge against similar offerings by Google and Apple. But this new Microsoft branded product, for which it controls the hardware and the software offerings, is a substantial risk for the technology behemoth.
Microsoft's competition extends far beyond just Apple and Samsung. Dell, Hewlett-Packard, Asus, Lenovo, and others are not only Microsoft licensees, but also vie for a share in the growing tablet market. One cannot help but wonder if Microsoft's overt entry into this market could alienate one or more of its core customers.
Apple currently holds about a 65% share of the tablet market with its iPad line. Apple's secret to success has been controlling all of the hardware and operating system software of its products, built in tandem so that design efficiencies are maximized. No other computer, phone, or tablet maker controls its own hardware and operating system. This is the model for Microsoft, and with its huge $60 billion cash hoard, it has the resources to develop, and equally important, market the product as a preferable alternative to Apple and Droid.
Elsewhere in Microsoft's universe, things are mostly solid. Its new Windows 8 system could be a real game changer, allowing customers identical interfaces between their phones, tablets, computers, and game consoles. The full Windows 8 system should be available in the 4th quarter of this year, and I expect tremendous hype surrounding its release.
Speaking of phones, Microsoft's deal with Nokia has been a letdown so far. With the Lumia 900 acting as the only widely available model to use the Microsoft operating system, they have generally been met with disappointing sales. Microsoft's relative timidity in the cell phone business sharply contrasts with Google’s bold, and expensive $12.5 billion purchase of Motorola Mobility.
Microsoft's moves give it more upside than it had a year ago, though they do supply additional risks. I generally applaud the company for shaking things up. Wall Street has long ago stopped rewarding Microsoft for its consistent earnings gains. Its 2011 earnings, for instance, came to $23.2 billion, or $2.69 per share. It has a current dividend yield of 2.7%. The stock spent 2011 mostly between $24 and $29 per share. Ten years ago, in 2002, earnings were $10.4 billion, or $1.07 per share. There was no dividend, and the stock traded as high as $35.30 per share. Microsoft's stock has essentially just been treading water for a dozen or more years; all the while the company's profits grew, and its price to earnings ratios shrunk. I hope the current moves jolt the investing public into recognizing what an earnings juggernaut Microsoft now is and will most likely continue to be. At eleven times earnings, it looks as undervalued as any mega-capitalization stock out there.
A smaller tech company I have been following (and liking) is CACI International (NYSE: CACI). CACI is essentially a government contractor. In 2011, 80% of its revenues came from the Department of Defense, and various federal agencies accounted for another 15%. CACI operates in a niche, upgrading antiquated legacy computer systems.
Over the past ten years, CACI's revenues and profits have both averaged 17% annual gains. But now there is significant pressure on spending cuts in all areas of government, including the Defense Department, so investors view CACI's business as under threat. In early May, CACI management cut its revenue estimates for fiscal 2012 from as high as $4.05 billion, down to about $3.78 billion, and Wall Street reacted violently.
It is that price reaction that has me high on the stock. It is now trading about 12 points, or 20%, below its early May price, and management has not adjusted downward earnings expectations. The company is trading at a price to earnings ratio of under 9.
Over the longer haul, I believe that government computer systems would always need to be maintained at the highest levels of efficiency, especially in the Defense Department. I see CACI finishing 2012 off strongly on the earnings front, but then struggling with federal budget issues in 2013. Management is looking for sharp earnings increases in 2013. After that though, there may well be pent up demand for CACI's unique relationships and expertise, and I believe both the stock and company have tremendous growth potential over the long term. I encourage you to look into it.
Oracle (NASDAQ: ORCL) is a much larger tech company, and perhaps the world's leading supplier of database software. It quite seamlessly integrated Sun Microsystems in 2010, so it is now involved in hardware as well as its traditional software business.
Oracle was planning to release its latest quarterly earnings report on June 21; it moved that date up to June 18. For all of 2012, software revenues were up by 9%, but hardware revenues, the result of the Sun acquisition, were down by 14%. Profits for the year were $12.52 billion, or $2.46 per share, a 10% improvement from fiscal 2011.
I do not see any sign of an imminent turnaround in Oracle's hardware business. IBM and Dell dominate that segment of the market, and Sun's systems, which were struggling in 2010, continue to struggle today. But Oracle's market penetration (it has contracts will all of the Fortune 100 companies) and expense controls have helped its profit margins to steadily expand, from the low 20% range a decade ago to 33% in 2012. I see further increases in that margin, with earnings increasing at a low double digit clip. This premier technology company has a sterling balance sheet and should appeal to conservative investors.
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