A week ago, after Microsoft's acquisition of Skype was announced, my friend Jacob Wolinsky wrote an article about why he sold Microsoft. Since we still hold Microsoft in our capital appreciation portfolio, I thought I would write about why we still own it.
First, let me be clear. Jacob and I agree on a lot of things when it comes to Microsoft. Skype was a terrible acquisition. Steve Ballmer is not a good CEO of Microsoft; and Bill Gates, its Chairman of the Board, should stick to running his charity. We agree on the economic moat Microsoft has and that the stock is cheap. But I believe the economic moat Microsoft has far outweighs the idiocy of the two captains running the ship. As Warren Buffett has said, "I try to buy stock in businesses that are so wonderful that an idiot can run them. Because sooner or later, one will."
The list of failed acquisitions and product blunders under Ballmer's tenure is long and stunning:
(1) aQuantive for $6B in 2007, which is still losing money; (2) Danger for $500M in 2008, which is now essentially shut down; (3) Groove for $171M and the reason they bought it, Ray Ozzie, is now gone; (4) Placeware for $200M in 2003, which they turned into Live Meeting and are now phasing out in favor of Lync Online; (5) Massive, an in-game advertiser, for $280M in 2006, which was shut down last year. There's no doubt about it, billions of dollars of shareholder capital have been squandered.
And what about internal product development? That is beset by a long list of colossal failures as well. Windows ME and Vista were absolutely horrible with Windows ME being quite possibly one of the worst operating systems ever. Zune, Kin, Bing, Windows Mobile can be added to the list of terrible products relegated to second or third tier status by other competitors.
With such a terrible 10 year record, it shouldn't be surprising that Microsoft's business has floundered. Customers have deserted them in droves and the company is at death's door. Wait a second, that isn't what happened. In fact, the business results for the last 10 years haven't been half bad.
(all values in millions)
Revenue has grown 172% (11% compounded). Net Income has almost doubled (7% compounded). The core business is even more efficient with an ROA after excluding Microsoft's cash hoard of 38% versus 33.2% from 10 years ago. Even traditional ROA shows a modest improvement. In fact, despite the best efforts of Steve "The Destroyer of Shareholder Value" Ballmer's best efforts, Microsoft has proved quite resilient.
Most people's frustration with Microsoft stems from the price they paid. During the early part of the last decade, Microsoft regularly changed hands around 100, 50, 40 or 30 times earnings. With better management a multiple of 30 early in the decade may have been justified (barely) but nothing more. Now Microsoft trades at rock bottom prices. We might be stuck with Ballmer for another decade. If this decade turns out like the last one, Microsoft will have been an absolute steal at these prices.
The question of management's capability always poses an interesting conundrum to investors. Bruce Greenwald frames the management argument this way. Should good management lead to a higher multiple? Of course it should. Better management reinvests earnings more wisely and earns a higher rate of return. Should good management lead to a lower multiple? Of course, the managers have been good for a long time and the results are built into the business. Good managers have only one way to go and that is down.
With my investments, I choose to go the Warren Buffett route. I try to buy businesses that are so wonderful not even a Steve Ballmer can kill them. In fact, Warren himself even said he would buy Microsoft if he wasn't a close friend of Bill Gates.
Like a ship, Microsoft is sound; it's the captain Ballmer that is the problem. Hopefully we can mutiny soon. If not, at least we are in a seaworthy vessel.
Disclosure: Long Microsoft