The Graph of Microsoft’s (MSFT – Free Value Line Research Report) share price over the past decade or so isn’t particularly compelling. After hitting a high around $60 a share in 1998, the stock has fallen into a trading range between about $25 and $35. Worse, the stock’s relative price strength compared to the 1,700 companies Value Line covers has been uniformly poor, as the downward movement of the dotted line (relative strength line) on the graph clearly shows.
This poor stock performance seems strange for a company that has increased revenues and earnings at compounded annual rates of 13.5% and 11.0%, respectively. Moreover, it initiated a dividend in 2003 that has grown over 20% on an annualized basis over the past five years. The Annual Rates box displays these figures. Note from examining this box that the growth rates over the trailing five-year period were even stronger than those over the trailing 10-year period.
Looking at the historical portion of the Statistical Array shows in dollars and cents what the Annual Rates box turns into percentages. In 2000, Microsoft earned $0.85 per share. In 2010, the company earned $2.10 a share. The only disruption in the upward trend occurred in 2009, a result of the prolonged recession that ended early that year. (Recessions are marked in the Graph with a gray bar.) Note that until 2009, when historically low interest rates lured the company into taking on long-term debt, the company’s capital structure consisted entirely of stock. Moreover, the company boasts envious Return on Total Capital and Return on Shareholder Equity rates.
While some might have concerns about management’s decision to begin using debt as a funding source, debt represents less than 20% of the company’s capital structure, as shown in the Capital Structure box to the left of the Statistical Array. In addition, as the Current Position box, which is directly below the Capital Structure box, displays, the company’s cash balance has increased over the past three years, despite paying an increasing dividend and making interest payments on the recently sold debt. The cash balance as of December 31, 2010 was more than four times the company’s outstanding debt. Net debt, or the amount of debt reduced by cash on hand, would be zero. Although a portion of the company’s cash resides overseas, it is clear that the company has ample resources to deal with debt and fund its future.
These aren’t the statistics one would expect of a company with a range bound stock price that is currently half the level it was a decade ago. That said, Microsoft isn’t the same company it was at the time. No longer viewed as a growth stock with limitless potential, it is now seen as the old guard with utility-like qualities. Though this characterization has some truth to it, it could also be obscuring a more attractive underlying portrait.
Something of a reverse Dorian Gray, the “young” picture underlying Microsoft’s current image is that of a cash rich innovator willing to partner with competitors to solidify its position in the tech world. The innovation aspect can be seen in such groundbreaking products as Kinect, which allows users to use their bodies to control games. Interestingly, some users, including robotics aficionados, have been tinkering with the Kinect to make it control far more than just games. While Nintendo’s Wii controller started the ball rolling, Microsoft clearly took game control to a new level.
Although some view Microsoft’s operating systems and office productivity suites as staid and unlikely to gain market share, Microsoft isn’t sitting idly by waiting for others to eat its lunch. It is continuously upgrading these products, which, as Charles Clark notes in the Analyst Comment, has been a boon to recent results.
Where the company has had less success, however, has been in faster growing areas, such as search and cell phones. So, to some extend, there is a solid backing for the naysayers’ argument, especially when nimble companies like Google (GOOG) and Apple (AAPL) are playing such a dominant role in the current industry dynamics. To that end, Microsoft has been pairing up with other companies to take on this duo.
About a year ago, Microsoft and Yahoo! (YHOO) partnered in search, with Microsoft providing the search functionality to Yahoo’s website. Although something of a defeat for Yahoo!, which built its name in search, it was a major victory for Microsoft. The company has just launched an updated search tool, called bing, and was looking for ways to take market share from Google, which is the 800 lb gorilla of search. In one deal, Microsoft likely more than doubled its share of the market.
Although Microsoft is far from unseating Google, recent trends suggest that the bing/Yahoo! combo is nipping at the leader’s heels. Moreover, being number two in an important category can still be very profitable—think Pepsi (PEP) to Coke (KO – Free Value Line Research Report) or General Electric’s (GE – Free Value Line Research Report) famous maxim of being number one OR two in each industry. So while no showstopper, this deal is a potential winner for Microsoft, giving it an important seat at the banquet’s head table.
In another more recent deal, Microsoft will be providing the operating systems for Nokia’s (NOK) smart phones. Smart phones is an area where Microsoft is something of an also ran, trailing Apple’s iPhone, Research in Motion’s (RIMM) Blackberry, and Google’s Android operating system driven phones. Partnering with Nokia, which is still the world’s largest maker of cellphones, then, seems like something of a coup. Nokia is viewed as a laggard in the smart phone space, so there is little harm to Microsoft in supplying its technology, but if the world’s largest cellphone maker is successful in using Microsoft’s software, the market share gains could be considerable. This is true regardless of whether Nokia jumps to the front of the smartphone pack. Thus, with little risk to itself, Microsoft has the potential to gain a material foothold in an increasingly important area. (Read more about our opinion of Microsoft’s pair up with Nokia.)
To be sure, there is no short-term fix that will result in Microsoft shares doubling overnight. That said, the company appears to have a solid foundation on which it can force itself into important growth markets, even if it doesn’t become the lead competitor in the space. True, the company is not the tech darling it used to be, but that hardly means this innovative company is floundering. It may just be a victim of its past success and ever-greater size.
At the time of this article's writing, the author did not have positions in any of the companies mentioned.