On Microsoft

On Microsoft



On Microsoft
Microsoft is​ a​ difficult situation for​ me to​ evaluate .​
I​ think the​ company still has a​ lot of​ growth ahead in​ some areas .​
But, that depends on where management wants to​ take it.
There are three core businesses that are already well developed: Windows, Office, and​ Servers.
The moat in​ the​ first two are wide .​
The Windows moat is​ huge.
The business model in​ operating systems is​ great .​
You keep upgrading every few years; the​ hardware needn't progress for​ you to​ find things to​ tweak and​ get people to​ buy the​ next step up .​
It's insanely profitable.
I think the​ new launch (Vista) will be bigger than people expect (eventually) in​ how it​ allows for​ cross selling other Microsoft products (but we'll see about that) .​
I​ expect the​ press to​ be very negative at​ least until well after the​ launch, because there will always be some bugs and​ delays.
Games
Eventually, video games will be a​ big business for​ Microsoft .​
I​ hate the​ economics of​ the​ console business, but love the​ economics of​ the​ publishing (and development) side of​ things.
I'm sorry to​ see that Microsoft didn't use its cash pile to​ buy up an​ established business here (publishers were cheap in​ the​ market a​ few years ago; an​ all cash deal would have worked well .​
Now, everyone thinks video games will be the​ next big thing).
The console wars are going well for​ Microsoft .​
The two keys to​ establishing a​ dominant console are launching first and​ getting good games on your platform .​
We'll see how Sony (SNE) does this round, but I​ expect them to​ be the​ big loser.
Nintendo may surprise here .​
I​ think the​ Xbox 360 and​ Nintendo's new console (Wii) will do very well .​
It'll be interesting to​ see the​ breakdown of​ the​ consoles in​ both the​ domestic and​ foreign markets .​
I​ think Sony may still be strong overseas, but could be in​ a​ much poorer position at​ the​ end of​ this round than they were with the​ PS2.
Search
Long-term I​ am optimistic about search .​
I​ think Google's position is​ much weaker than most people think .​
I​ don't think Microsoft will be the​ only one to​ benefit here.
Search is​ a​ very natural cross sell with Windows .​
That's the​ direction everything seems to​ be headed in​ (combining online and​ desktop search) .​
For future growth in​ terms of​ market share I​ think Microsoft is​ in​ a​ better position than either Yahoo (YHOO) or​ Google (GOOG).
I also think we might see a​ couple other (largely unknown) search engines gain some share.
I think Google's strength is​ its brand .​
Its dominance helps with advertisers more than users .​
I​ don't think it​ has a​ lock on users .​
Also, I​ think Google has been poorly positioned for​ doing much of​ anything outside of​ keyword search.
I expect to​ see a​ lot more in​ the​ way of​ intelligent, social search inspired stuff .​
Years from now, much of​ search will have to​ be helping you find what you didn't know you wanted to​ find.
Google is​ dominant in​ a​ different business: helping you find what you know you want to​ find (but don't know the​ name / location) .​
The two types of​ search are very different .​
Both will be important, but the​ growth in​ other forms of​ search will be coming off a​ smaller base and​ will likely integrate with keyword search .​
Google has the​ most to​ lose here.
Other Devices
Microsoft wants to​ perform well on mobile devices and​ on your TV .​
Compared to​ competitors it​ is​ very strong in​ these respects.
The strategy seems to​ be the​ one I​ would favor - to​ control the​ point of​ initial contact wherever software is​ used and​ then to​ only venture into the​ actual application or​ content side of​ the​ business where it​ is​ highly profitable to​ do so .​
In video games it​ will be highly profitable .​
In other areas it​ is​ less likely to​ be very profitable.
I expect to​ see more generic, web-based applications .​
These will be less profitable for​ everyone .​
Office should hold up well, but not as​ well as​ Windows .​
Basically, Microsoft needs to​ take what it​ has in​ PCs and​ import that to​ TVs, Handheld Devices, Consoles, and​ the​ Web.
That should be the​ strategy .​
I​ think that is​ the​ strategy .​
These aren't unrelated businesses that need to​ be broken up to​ unlock creativity (as some have suggested) .​
Rather, the​ profit potential for​ each is​ greatly enhanced by being part of​ Microsoft .​
If you take these pieces apart they are worth very little .​
There would only be the​ three businesses I​ started off talking about and​ the​ console / games business.
Internationally, there is​ going to​ be natural growth for​ Microsoft's dominant businesses .​
It won't be a​ tremendous growth rate, but it​ will be strong and​ will require virtually no additional investment to​ secure.
Obsolescence Issues
Overall, I​ like the​ future for​ software a​ lot more than hardware, because the​ marginal gains in​ the​ quality of​ hardware will slow greatly in​ the​ years ahead.
The question isn't what can be done mathematically in​ terms of​ increasing specs; it's what that translates to​ for​ the​ user .​
We are reaching a​ point where the​ individual user will not directly see the​ benefits of​ increased hardware performance as​ clearly as​ he did in​ the​ past.
Much of​ the​ research that goes in​ to​ this area will only serve to​ bring down prices and​ benefit memory intensive businesses - it​ will not provide as​ much of​ a​ wow factor for​ the​ user anymore.
This is​ especially true in​ games .​
The situation in​ desktop applications is​ already such that improving the​ software design is​ where most gains will come from.
Computing power is​ simply not a​ scarce resource for​ most individuals sitting at​ home or​ in​ a​ cubicle .​
Advances will benefit some users a​ lot and​ will trickle down to​ the​ end user (often via the​ web) through fast responses and​ cheap services .​
But, that's a​ barely noticeable change.
You'll see something here akin to​ the​ kind of​ thing you see in​ the​ brokerage business .​
It won't be obvious, because price competition will never be as​ great in​ software.
Generally, you'll just see the​ prices for​ doing anything electronically come down .​
That's very different from what we've seen over the​ last few decades, where you also had advancements that attracted new users, because they allowed developers to​ do something differently, not just more cheaply.
This is​ a​ very long-term trend I'm worried about .​
It could weigh heavily on a​ business like Dell (DELL), because PCs are actually quite durable; once the​ rate of​ obsolescence slows, sales will have to​ slow as​ the​ cycle lengthens.
Management
I think Microsoft's management is​ absolutely the​ best in​ the​ business .​
In fact, I​ think it's one of​ the​ best in​ any business.
It would be hard for​ me to​ find more than a​ handful of​ people I'd rather have managing a​ business I​ was part owner of​ .​
I​ also think the​ current arrangement is​ a​ good one.
There is​ enough of​ a​ line between current operations and​ future investments in​ the​ Chairman / CEO split that investors will probably get the​ greatest benefit from the​ brilliance of​ the​ Chairman this way.
Everyone underestimates Bill Gates .​
It's easy, because his great triumph came some time ago now .​
But, he's interested in​ building something lasting .​
I​ trust him more than anyone in​ tech without a​ question .​
He always impresses me whether he's talking about his own industry or​ some other topic .​
He has exactly the​ right kind of​ mind for​ someone running a​ business where the​ long-run is​ such a​ concern.
Qualitatively, I​ think Microsoft scores close to​ perfectly .​
I​ could cite the​ profitability stats, but I​ won't, because you know they're better than almost any other business on the​ planet – and​ that's with a​ huge siphoning off of​ resources to​ investments in​ the​ future that aren't required to​ maintain the​ cash cow, wide-moat Windows franchise.
Valuation
Valuation is​ a​ bit more troubling .​
Microsoft is​ not at​ the​ point on an​ EV/EBIT basis where I'd be buying the​ stock if​ there was a​ risk of​ no extraordinarily profitable growth in​ the​ future .​
In other words, at​ the​ current price, it​ clearly makes for​ a​ bad bond.
The key is​ earnings growth .​
I​ think you have to​ believe MSFT will have a​ real future in​ search, games, and​ non-PC devices that will fuel future, highly profitable growth.
I think that future is​ there .​
As far as​ a​ truly large cap stock (say $10 billion or​ more) it's about as​ attractive as​ anything on the​ planet right now - and​ certainly it's the​ most attractive stock of​ any very large U.S .​
business .​
Even though Intel (INTC) and​ Dell are cheap looking, I​ don't like them nearly as​ much .​
Dell is​ an​ interesting situation, but I​ don't understand the​ business well enough.
I have a​ better idea of​ where MSFT is​ headed – and​ I​ like it.
Conclusion
I don't own shares of​ MSFT .​
I​ won't be buying any either .​
I​ don't normally own such large stocks .​
I​ prefer much smaller businesses, because the​ mispricings tend to​ get more out of​ whack .​
You aren't going to​ see MSFT trade at​ an​ EV/EBIT of​ 7.5 or​ something like that, but you do sometimes get those chances in​ small (high quality) businesses.
There are a​ lot of​ chances to​ find wild mispricings without much of​ the​ future being a​ concern .​
Those are the​ situations I​ prefer to​ invest in, because businesses like MSFT have an​ awfully large anchor with the​ amount of​ capital they've got – plus, they tend to​ be less likely to​ be wildly mispriced.
However, if​ I​ had to​ own one business with a​ market cap of​ more than $10 billion and​ hold it​ for​ a​ lifetime I​ would buy Microsoft here without hesitation.




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