Microsoft is no longer a growth investment
In the late '90s, I shifted most of my investments from moderate to high growth into low to moderate growth / moderate income. That's how I was able to weather much of the capital loss unlike many others (I only saw a 5% drop in my worst year), when the .COM bust came and popular growth funds with overvalued stock, like Microsoft, came tumbling down. Although it was clear that Microsoft was making significant investments to stablize its income, most investors who stuck around, or invested in Microsoft after the drop, were okay since Microsoft still had its extreme profit margins on Office and Windows.
Well, that time is now over.
Although some investors are optimistic, Microsoft itself is quickly becoming a software services and investment firm, and no longer a volume software developer. Microsoft has seen losses in its Office and Windows products renewals, gimmicks like software assurance alienate even its most loyal customers as they pay more than if they would just have upgraded incrementally each version and a growing trend of disgruntled Microsoft Gold Partners and certified professionals due to being blamed for patch management issues that are at the fault of Microsoft itself (e.g., "keeping current" caused enterprises to be suseptible to SQL Slammer, because newer patches uninstalled an older fix that would have prevented it).
Without the extreme profits on Office and Windows, which have virtually no cost to reproduced with the same, fixed development costs, Microsoft will never be as profitable as it was just 5 years ago -- let alone nothing like 5 years before that. At the same time, Microsoft is forced to pay recurring infrastructure and, more costly, consulting and personnel costs to provide services to compete with Google and others. So relying more and more on outside investments and more moderate profits on services mean Microsoft's days as a growth fund are over. Microsoft is becoming a regular Blue Chip although their history on income is far from historical Blue Chip. Microsoft's past is filled with investement interest on pure growth only, with 0 dividen payments until recently (just after a very enlightening set of investigations on how Microsoft is not good for our economy by Ralph Nader, among others). It remains to be seen if dividen payments can turn Microsoft into a solid income stock, or if it's really just a redistribution of their existing cash reserves.
Which is where the real trouble begins ...
The only entities allied with Microsoft that are still happy are the Tier-1 OEMs, superstores and the hardware vendors whose products the superstores sell. Unfortunately, as Microsoft's margins decrease and they dip into cash to pay income, that undercuts Microsoft's #1 means of distribution control -- R&D pay-offs. As Intel is finding out first-hand itself -- it's a double-whammy. It's more than just the competition forcing you to lower prices, while you're alienating your consumer who now buys less at the same time, causing your profits to sink. It's the fact that your past, extreme profits have allowed you to spend hundreds of millions in R&D for your partners for their loyalty -- cash you no longer have to do such (without dipping into your cash reserves).
The result is that you lose your distribution loyalty base, and that is the mainstay of Microsoft, just like Intel. The next step is litigation and then counter-litigation. This is Intel today, who has lost the retail distribution with only a 15% marketshare (AMD has nearly 85%), and is losing heavily on the core OEM -- especially servers where AMD jumped from only 5% to 14% in a year where Intel is 33% slower and 50% more costly (let alone AMD has a more compatible, reliable and stable design -- something Microsoft is also fighting Open Source Software, OSS, from a long-term "risk to data" standpoint). Now it took Intel 5 years to reach that point, but don't be surprised in 2011-2012 if Microsoft is starting to feel it just the same.
Because once you stop sending the R&D money, even the unthinkable happens. Like Dell moving away from all Intel-bsaed system components and even considering AMD -- just because its customers want it. And when you try to limit what your partners can do -- like Intel has been with HP (forcing them to sell less than 10% of their servers with AMD) -- you get lawsuits for preventing consumers from buying what they want (because HP has been selling over 30%, and over 50% of HP's customers now prefer AMD for servers). Microsoft is going to start feeling the same from Apple, among others, on the distribution channel -- especially as Apple is replacing Dell as Intel's #1 partner, or the superstores/tier-1 OEMs try to avoid anything but Microsoft.
Now Microsoft, like Intel, will still be around -- long-term Blue Chip companies, just not so much for their past products volume. Microsoft is slowly losing its profits which, again, will directly impact its ability to control its distribution channel -- namely tier-1 OEMs and core providers. But it isn't because someone is trying to directly compete with Microsoft in that distribution channel of their core products. It's because someone was chipping away at their related software services when Microsoft thought it wasn't worth their bother (and outsourced much of it) -- namely Google. But because of Google, Microsoft is finding it's got the double-whammy of affecting money for its distribution channel -- as you'll be seeing over the next 5 years. Microsoft is being forced to compete at margins it's not used to, to fend off Google -- as well as other markets it has (almost without thought) entered like entertainment that has far less profit.
Intel has the same problem, only 5 years newer. It wasn't because AMD was directly challenging Intel at the Tier-1 OEM. They came in through the retail channel. Now they've started socking it to them on the high profit margin server channel -- so much so that even Dell can't ignore the signficiant superiority of AMD's server platform versus Intel. Intel won't go away, but they completely lost the retail market, and are still 2+ years away from partially addressing the server market -- and still not with a solution that is on-par with AMD, who is not standing still.
Intel is a solid Blue Chip, bit not only is it no longer the growth it once was -- it's been negative at times. Microsoft is entering this same period where it's going to see its market cap drop again, as more investors realize that software services are never going to deliver the profits that just software volume does. So like Intel, you will wish you sold your stock sooner, to avoid more market cap loss -- even if you want to hold Microsoft in the future. Buy it back in 5 years, when its cheaper and the income is more proportional to its market cap.
Microsoft is still a sound, long-term investment, just not at its current market capitalization. And that's the problem for people who will hold on to the stock over the next 3-5 years.
Well, that time is now over.
Although some investors are optimistic, Microsoft itself is quickly becoming a software services and investment firm, and no longer a volume software developer. Microsoft has seen losses in its Office and Windows products renewals, gimmicks like software assurance alienate even its most loyal customers as they pay more than if they would just have upgraded incrementally each version and a growing trend of disgruntled Microsoft Gold Partners and certified professionals due to being blamed for patch management issues that are at the fault of Microsoft itself (e.g., "keeping current" caused enterprises to be suseptible to SQL Slammer, because newer patches uninstalled an older fix that would have prevented it).
Without the extreme profits on Office and Windows, which have virtually no cost to reproduced with the same, fixed development costs, Microsoft will never be as profitable as it was just 5 years ago -- let alone nothing like 5 years before that. At the same time, Microsoft is forced to pay recurring infrastructure and, more costly, consulting and personnel costs to provide services to compete with Google and others. So relying more and more on outside investments and more moderate profits on services mean Microsoft's days as a growth fund are over. Microsoft is becoming a regular Blue Chip although their history on income is far from historical Blue Chip. Microsoft's past is filled with investement interest on pure growth only, with 0 dividen payments until recently (just after a very enlightening set of investigations on how Microsoft is not good for our economy by Ralph Nader, among others). It remains to be seen if dividen payments can turn Microsoft into a solid income stock, or if it's really just a redistribution of their existing cash reserves.
Which is where the real trouble begins ...
The only entities allied with Microsoft that are still happy are the Tier-1 OEMs, superstores and the hardware vendors whose products the superstores sell. Unfortunately, as Microsoft's margins decrease and they dip into cash to pay income, that undercuts Microsoft's #1 means of distribution control -- R&D pay-offs. As Intel is finding out first-hand itself -- it's a double-whammy. It's more than just the competition forcing you to lower prices, while you're alienating your consumer who now buys less at the same time, causing your profits to sink. It's the fact that your past, extreme profits have allowed you to spend hundreds of millions in R&D for your partners for their loyalty -- cash you no longer have to do such (without dipping into your cash reserves).
The result is that you lose your distribution loyalty base, and that is the mainstay of Microsoft, just like Intel. The next step is litigation and then counter-litigation. This is Intel today, who has lost the retail distribution with only a 15% marketshare (AMD has nearly 85%), and is losing heavily on the core OEM -- especially servers where AMD jumped from only 5% to 14% in a year where Intel is 33% slower and 50% more costly (let alone AMD has a more compatible, reliable and stable design -- something Microsoft is also fighting Open Source Software, OSS, from a long-term "risk to data" standpoint). Now it took Intel 5 years to reach that point, but don't be surprised in 2011-2012 if Microsoft is starting to feel it just the same.
Because once you stop sending the R&D money, even the unthinkable happens. Like Dell moving away from all Intel-bsaed system components and even considering AMD -- just because its customers want it. And when you try to limit what your partners can do -- like Intel has been with HP (forcing them to sell less than 10% of their servers with AMD) -- you get lawsuits for preventing consumers from buying what they want (because HP has been selling over 30%, and over 50% of HP's customers now prefer AMD for servers). Microsoft is going to start feeling the same from Apple, among others, on the distribution channel -- especially as Apple is replacing Dell as Intel's #1 partner, or the superstores/tier-1 OEMs try to avoid anything but Microsoft.
Now Microsoft, like Intel, will still be around -- long-term Blue Chip companies, just not so much for their past products volume. Microsoft is slowly losing its profits which, again, will directly impact its ability to control its distribution channel -- namely tier-1 OEMs and core providers. But it isn't because someone is trying to directly compete with Microsoft in that distribution channel of their core products. It's because someone was chipping away at their related software services when Microsoft thought it wasn't worth their bother (and outsourced much of it) -- namely Google. But because of Google, Microsoft is finding it's got the double-whammy of affecting money for its distribution channel -- as you'll be seeing over the next 5 years. Microsoft is being forced to compete at margins it's not used to, to fend off Google -- as well as other markets it has (almost without thought) entered like entertainment that has far less profit.
Intel has the same problem, only 5 years newer. It wasn't because AMD was directly challenging Intel at the Tier-1 OEM. They came in through the retail channel. Now they've started socking it to them on the high profit margin server channel -- so much so that even Dell can't ignore the signficiant superiority of AMD's server platform versus Intel. Intel won't go away, but they completely lost the retail market, and are still 2+ years away from partially addressing the server market -- and still not with a solution that is on-par with AMD, who is not standing still.
Intel is a solid Blue Chip, bit not only is it no longer the growth it once was -- it's been negative at times. Microsoft is entering this same period where it's going to see its market cap drop again, as more investors realize that software services are never going to deliver the profits that just software volume does. So like Intel, you will wish you sold your stock sooner, to avoid more market cap loss -- even if you want to hold Microsoft in the future. Buy it back in 5 years, when its cheaper and the income is more proportional to its market cap.
Microsoft is still a sound, long-term investment, just not at its current market capitalization. And that's the problem for people who will hold on to the stock over the next 3-5 years.
1 comments:
Interesting. I just googled for Intel and Microsoft and looked at their balance sheets. Based on just a few data points, Microsoft appears headed down faster than Intel, as you said. Ray Ozzie has his work cut out for him.
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