by Adam Hartung | Feb 3, 2016 | Current Affairs, Leadership, Lifecycle, Web/Tech
The three highest valued publicly traded companies today (2/3/16) are Google/Alphabet, Apple and Microsoft. All 3 are tech companies, and they compete – although with different business models – in multiple markets. However, investor views as to their futures are wildly different. And that has everything to do with how the leadership teams of these 3 companies have explained their recent results, and described their futures.
Looking at the financial performance of these companies, it is impossible to understand the price/earnings multiple assigned to each. Apple clearly had better revenue and earnings performance in all but the most recent year. Yet, both Alphabet and Microsoft have price to earnings (P/E) multiples that are 3-4 times that of Apple.
Much was made this week about Alphabet’s valuation exceeding that of Apple’s. But the really big story is the difference in multiples. If Apple had a multiple even half that of Alphabet or Microsoft it’s value would be much, much higher.
But, as we can see, investors did the best over both 2 years and 5 years by investing in Microsoft. And Apple investors have fared the poorest of all 3 companies regardless of time frame. Looking at investment performance, one would think that the revenue and earnings performance of these companies would be the reverse of what’s seen in the first chart.
The missing piece, of course, is future expectations. In this column a few days ago, I pointed out that Apple has done a terrible job explaining its future. In that column I pointed out how Facebook and Amazon both had stratospheric P/E multiples because they were able to keep investors focused on their future growth story, even more than their historical financial performance.
Alphabet stole the show, and at least briefly the #1 valuation spot, from Apple by convincing investors they will see significant, profitable growth. Starting even before earnings announcements the company was making sure investors knew that revenues and profits would be up. But even more they touted the notion that Alphabet has a lot of growth in non-monetized assets. For example, vastly greater ad sales should be expected from YouTube and Google Maps, as well as app sales for Android phones through Google Play. And someday on the short horizon profits will emerge from Fiber transmission revenues, smart home revenues via Nest, and even auto market sales now that the company has logged over 1million driverless miles.
This messaging clearly worked, as Alphabet’s value shot up. Even though 99% of the company’s growth was in “core” products that have been around for a decade! Yes, ad revenue was up 15%, but most of that was actually on the company’s own web sites. And most was driven by further price erosion. The number of paid clicks were up 30%, but price/click was actually down yet another 15% – a negative price trend that has been happening for years. Eventually prices will erode enough that volume will not make up the difference – and what will investors do then? Rely on the “moonshot” projects which still have almost no revenue, and no proven market performance!
But, the best performer has been Microsoft. Investors know that PC sales have been eroding for years, that PC sales will continue eroding as users go mobile, and that PC’s are the core of Microsoft’s revenue. Investors also knows that Microsoft missed the move to mobile, and has practically no market share in the war between Apple’s iOS and Google’s Android. Further, investors have known forever that gaming (xBox,) search and entertainment products have always been a money-loser for Microsoft. Yet, Microsoft investors have done far better than Apple investors, and long-term better than Google investors!
Microsoft has done an absolutely terrific job of constantly trumpeting itself as a company with a huge installed base of users that it can leverage into the future. Even when investors don’t know how that eroding base will be leveraged, Microsoft continually makes the case that the base is there, that Microsoft is the “enterprise” brand and that those users will stay loyal to Microsoft products.
Forget that Windows 8 was a failure, that despite the billions spent on development Win8 never reached even 10% of the installed base and the company is even dropping support for the product. Forget that Windows 10 is a free upgrade (meaning no revenue.) Just believe in that installed base.
Microsoft trumpeted that its Surface tablet sales rose 22% in the last quarter! Yay! Of course there was no mention that in just the last 6 weeks of the quarter Apple’s newly released iPad Pro actually sold more units than all Surface tablets did for the entire quarter! Or that Microsoft’s tablet market share is barely registerable, not even close to a top 5 player, while Apple still maintains 25% share. And investors are so used to the Microsoft failure in mobile phones that the 49% further decline in sales was considered acceptable.
Instead Microsoft kept investors focused on improvements to Windows 10 (that’s the one you can upgrade to for free.) And they made sure investors knew that Office 365 revenue was up 70%, as 20million consumers now use the product. Of course, that is a cumulative 20million – compared to the 75million iPhones Apple sold in just one quarter. And Azure revenue was up 140% – to something that is almost a drop in the bucket that is AWS which is over 10 times the size of all its competitors combined.
To many, this author included, the “growth story” at Microsoft is more than a little implausible. Sales of its core products are declining, and the company has missed the wave to mobile. Developers are writing for iOS first and foremost, because it has the really important installed base for today and tomorrow. And they are working secondarily on Android, because it is in some flavor the rest of the market. Windows 10 is a very, very distant third and largely overlooked. xBox still loses money, and the new businesses are all relatively quite small. Yet, investors in Microsoft have been richly rewarded the last 5 years.
Meanwhile, investors remain fearful of Apple. Too many recall the 1980s when Apple Macs were in a share war with Wintel (Microsoft Windows on Intel processors) PCs. Apple lost that war as business customers traded off the Macs ease of use for the lower purchase cost of Windows-based machines. Will Apple make the same mistake? Will iPad sales keep declining, as they have for 2 years now? Will the market shift to mobile favor lower-priced Android-based products? Will app purchases swing from iTunes to Google Play as people buy lower cost Android-based tablets? Have iPhone sales really peaked, and are they preparing to fall? What’s going to happen with Apple now? Will the huge Apple mobile share be eroded to nothing, causing Apple’s revenues, profits and share price to collapse?
This would be an interesting academic discussion were the stakes not so incredibly high. As I said in the opening paragraph, these are the 3 highest valued public companies in America. Small share price changes have huge impacts on the wealth of individual and institutional investors. It is rather quite important that companies tell their stories as good as possible (which Apple clearly has not, and Microsoft has done extremely well.) And likewise it is crucial that investors do their homework, to understand not only what companies say, but what they don’t say.
by Adam Hartung | Oct 25, 2015 | Current Affairs, Defend & Extend, Food and Drink, In the Swamp, In the Whirlpool, Leadership, Web/Tech
This week McDonald’s and Microsoft both reported earnings that were higher than analysts expected. After these surprise announcements, the equities of both companies had big jumps. But, unfortunately, both companies are in a Growth Stall and unlikely to sustain higher valuations.
McDonald’s profits rose 23%. But revenues were down 5.3%. Leadership touted a higher same store sales number, but that is completely misleading.
McDonald’s leadership has undertaken a back to basics program. This has been used to eliminate menu items and close “underperforming stores.” With fewer stores, loyal customers were forced to eat in nearby stores – something not hard to do given the proliferation of McDonald’s sites. But some customers will go to competitors. By cutting stores and products from the menu McDonald’s may lower cost, but it also lowers the available revenue capacity. This means that stores open a year or longer could increase revenue, even though total revenues are going down.
Profits can go up for a raft of reasons having nothing to do with long-term growth and sustainability. Changing accounting for depreciation, inventory, real estate holdings, revenue recognition, new product launches, product cancellations, marketing investments — the list is endless. Further, charges in a previous quarter (or previous year) could have brought forward costs into an earlier report, making the comparative quarter look worse while making the current quarter look better.
Confusing? That’s why accounting changes are often called “financial machinations.” Lots of moving numbers around, but not necessarily indicating the direction of the business.
McDonald’s asked its “core” customers what they wanted, and based on their responses began offering all-day breakfast. Interpretation – because they can’t attract new customers, McDonald’s wants to obtain more revenue from existing customers by selling them more of an existing product; specifically breakfast items later in the day.
Sounds smart, but in reality McDonald’s is admitting it is not finding new ways to grow its customer base, or sales. The old products weren’t bringing in new customers, and new products weren’t either. As customer counts are declining, leadership is trying to pull more money out of its declining “core.” This can work short-term, but not long-term. Long-term growth requires expanding the sales base with new products and new customers.
Perhaps there is future value in spinning off McDonald’s real estate holdings in a REIT. At best this would be a one-time value improvement for investors, at the cost of another long-term revenue stream. (Sort of like Chicago selling all its future parking meter revenues for a one-time payment to bail out its bankrupt school system.) But if we look at the Sears Holdings REIT spin-off, which ostensibly was going to create enormous value for investors, we can see there were serious limits on the effectiveness of that tactic as well.
MIcrosoft also beat analysts quarterly earnings estimate. But it’s profits were up a mere 2%. And revenues declined 12% versus a year ago – proving its Growth Stall continues as well. Although leadership trumpeted an increase in cloud-based revenue, that was only an 8% improvement and obviously not enough to offset significant weakness in other markets:
It is a struggle to see the good news here. Office 365 revenues were up, but they are cannibalizing traditional Office revenues – and not fast enough to replace customers being lost to competitive products like Google OfficeSuite, etc.
Azure sales were up, but not fast enough to replace declining Windows sales. Further, Azure competes with Amazon AWS, which had remarkable results in the latest quarter. After adding 530 new features, AWS sales increased 15% vs. the previous quarter, and 78% versus the previous year. Margins also increased from 21.4% to 25% over the last year. Azure is in a growth market, but it faces very stiff competition from market leader Amazon.
We build our companies, jobs and lives around successful products and services. We want these providers to succeed because it makes our lives much easier. We don’t like to hear about large market leaders losing their strength, because it signals potentially difficult change. We want these companies to improve, and we will clutch at any sign of improvement.
As investors we behave similarly. We were told large companies have vast customer bases, strong asset bases, well known brands, high switching costs, deep pockets – all things Michael Porter told us in the 1980s created “moats” protecting the business, keeping it protected from market shifts that could hurt sales and profits. As investors we want to believe that even though the giant company may slip, it won’t fall. Time and size is on its side we choose to believe, so we should simply “hang on” and “ride it out.” In the future, the company will do better and value will rise.
As a result we see that Growth Stall companies show a common valuation pattern. After achieving high valuation, their equity value stagnates. Then, hopes for a turn-around and recovery to new growth is stimulated by a few pieces of good news and the value jumps again. Only after a few years the short-term tactics are used up and the underlying business weakness is fully exposed. Then value crumbles, frequently faster than remaining investors anticipated.
McDonald’s valuation rose from $62/share in 2008 to reach record $100/share highs in 2011. But valuation then stagnated. It is only this last jump that has caused it to reach new highs. But realize, this is on a smaller number of stores, fewer products and declining revenues. These are not factors justifying sustainable value improvement.
Microsoft traded around $25/share from March, 2003 through November, 2011 – 8.5 years. When the CEO was changed value jumped to $48/share by October, 2014. After dipping, now, a year later Microsoft stock is again reaching that previous valuation ($50/share). Microsoft is now valued where it was in December, 2002 (which is half its all-time high.)
The jump in value of McDonald’s and Microsoft happened on short-term news regarding beating analysts earnings expectations for one quarter. The underlying businesses, however, are still suffering declining revenue. They remain in Growth Stalls, and the odds are overwhelming that their values will decline, rather than continue increasing.
by Adam Hartung | Jul 8, 2015 | Current Affairs, Defend & Extend, In the Whirlpool, Leadership, Lock-in, Web/Tech
Microsoft announced today it was going to shut down the Nokia phone unit, take a $7.6B write-off (more than the $7.2B they paid for it,) and lay off another 7,800 employees. That makes the layoffs since CEO Nadella took the reigns almost 26,000. Finding any good news in this announcement is a very difficult task.
Unfortunately, since taking over as Microsoft’s #1 leader, Mr. Nadella has been remarkably predictable. Like his peer CEOs who take on the new role, he has slashed and burned employment, shut down at least one big business, taken massive write-offs, and undertaken at least one wildly overpriced acquisition (Minecraft) that is supposed to be a game changer for the company. He apparently picked up the “Turnaround CEO Playbook” after receiving the job and set out on the big tasks!
Yet he still has not put forward a strategy that should encourage investors, employees, customers or suppliers that the company will remain relevant long-term. Amidst all these big tactical actions, it is completely unclear what the strategy is to remain a viable company as customers move, quickly and in droves, to mobile devices using competitive products.
I predicted here in this blog the week Steve Ballmer announced the acquisition of Nokia in September, 2013 that it was “a $7.2B mistake.” I was off, because in addition to all the losses and restructuring costs Microsoft endured the last 7 quarters, the write off is $7.6B. Oops.
Why was I so sure it would be a mistake? Because between 2011 and 2013 Nokia had already lost half its market share. CEO Elop, who was previously a Microsoft senior executive, had committed Nokia completely to Windows phones, and the results were already catastrophic. Changing ownership was not going to change the trajectory of Nokia sales.
Microsoft had failed to build any sort of developer community for Windows 8 mobile. Developers need people holding devices to buy their software. Nokia had less than 5% share. Why would any developer build an app for a Windows phone, when almost the entire market was iOS or Android? In fact, it was clear that developing rev 2, 3, and 4 of an app for the major platforms was far more valuable than even bothering to port an app into Windows 8.
Nokia and Windows 8 had the worst kind of tortuous whirlpool – no users, so no developers, and without new (and actually unique) software there was nothing to attract new users. Microsoft mobile simply wasn’t even in the game – and had no hope of winning. It was already clear in June, 2012 that the new Windows tablet – Surface – was being launched with a distinct lack of apps to challenge incumbents Apple and Samsung.
By January, 2013 it was also clear that Microsoft was in a huge amount of trouble. Where just a few years before there were 50 Microsoft-based machines sold for every competitive machine, by 2013 that had shifted to 2 for 1. People were not buying new PCs, but they were buying mobile devices by the shipload – literally. And there was no doubt that Windows 8 had missed the mobile market. Trying too hard to be the old Windows while trying to be something new made the product something few wanted – and certainly not a game changer.
A year ago I wrote that Microsoft has to win the war for developers, or nothing else matters. When everyone used a PC it seemed that all developers were writing applications for PCs. But the world shifted. PC developers still existed, but they were not able to grow sales. The developers making all the money were the ones writing for iOS and Android. The growth was all in mobile, and Microsoft had nothing in the game. Meanwhile, Apple and IBM were joining forces to further displace laptops with iPads in commercial/enterprise uses.
Then we heard Windows 10 would change all of that. And flocks of people wrote me that a hybrid machine, both PC and tablet, was the tool everyone wanted. Only we continue to see that the market is wildly indifferent to Windows 10 and hybrids.
Imagine you write with a fountain pen – as most people did 70 years ago. Then one day you are given a ball point pen. This is far easier to use, and accomplishes most of what you want. No, it won’t make the florid lines and majestic sweeps of a fountain pen, but wow it is a whole lot easier and a darn site cheaper. So you keep the fountain pen for some uses, but mostly start using the ball point pen.
Then the fountain pen manufacturer says “hey, I have a contraption that is a ball point pen, sort of, and a fountain pen, sort of, combined. It’s the best of all worlds.” You would likely look at it, but say “why would I want that. I have a fountain pen for when I need it. And for 90% of the stuff I write the ball point pen is great.”
That’s the problem with hybrids of anything – and the hybrid tablet is no different. The entrenched sellers of old technology always think a hybrid is a good idea. But once customers try the new thing, all they want are advancements to the new thing. (Just look at the interest in Tesla cars compared to the stagnant sales of hybrid autos.)
And we’re up to Surface 3 now. When I pointed out in January, 2013 that the markets were rapidly moving away from Microsoft I predicted Surface and Surface Pro would never be important products. Reader outcry at that time from Microsoft devotees was so great that Forbes editors called me on the carpet and told me I lacked the data to make such a bold prediction. But I stuck by my guns, we changed some language so it was less blunt, and the article ran.
Two and a half years later and we’re up to rev number Surface 3. And still, almost nobody is using the product. Less than 5% market share. Right again. It wasn’t a technology prediction, it was a market prediction. Lacking app developers, and a unique use, the competition was, and remains, simply too far out front.
Windows 10 is, unfortunately, a very expensive launch. And to get people to use it Microsoft is giving it away for free. The hope is then users will hook onto the cloud-based Office 365 and Microsoft’s Azure cloud services. But this is still trying to milk the same old cow. This approach relies on people being completely unwilling to give up using Windows and/or Office. And we see every day that millions of people are finding alternatives they like just fine, thank you very much.
Gamers hated me when I recommended Microsoft should give (for free) xBox to Nintendo. Unfortunately, I learned few gamers know much about P&Ls. They all assumed Microsoft made a fortune in gaming. But anyone who’s ever looked at Microsoft’s financial filings knows that the Entertainment Division, including xBox, has been a giant money-sucking hole. If they gave it away it would save money, and possibly help leadership figure out a strategy for profitable growth.
Unfortunately, Microsoft bought Minecraft, in effect “doubling down” on the bet. But regardless of how well anyone likes the products, Microsoft is not making money. Gaming is a bloody war where Sony and Microsoft keep battling, and keep losing billions of dollars. The odds of ever earning back the $2.5B spent on Minecraft is remote.
The greater likelihood is that as write offs continue to eat away at profits, and as markets continue evolving toward mobile products offered by competitors hurting “core” Microsoft sales, CEO Nadella will eventually have to give up on gaming and undertake another Nokia-like event.
All investors risk looking at current events to drive decision-making. When Ballmer was sacked and Nadella given the CEO job the stock jumped on euphoria. But the last 18 months have shown just how bad things are for Microsoft. It is a near monopolist in a market that is shrinking. And so far Mr. Nadella has failed to define a strategy that will make Microsoft into a company that does more than try to milk its heritage.
I said the giant retailer Sears Holdings would be a big loser the day Ed Lampert took control of the company. But hope sprung eternal, and investors jumped on the Sears bandwagon, believing a new CEO would magically improve a worn out, locked-in company. The stock went up for over 2 years. But, eventually, it became clear that Sears is irrelevant and the share price increase was unjustified. And the stock tanked.
Microsoft looks much the same. The actions we see are attempts to defend & extend a gloried history. But they don’t add up to a strategy to compete for the future. HoloLens will not be a product capable of replacing Windows plus Office revenues. If developers are attracted to it enough to start writing apps. Cortana is cool, but it is not first. And competitive products have so much greater usage that developer learning curve gains are wildly faster. These products are not game changers. They don’t solve large, unmet needs.
And employees see this. As I wrote in my last column, it is valuable to listen to employees. As the bloom fell off the rose, and Nadella started laying people off while freezing pay, employee support of him declined dramatically. And employee faith in leadership is far lower than at competitors Apple and Google.
As long as Microsoft keeps playing catch up, we should expect more layoffs, cost cutting and asset sales. And attempts at more “hail Mary” acquisitions intended to change the company. All of which will do nothing to grow customers, provide better jobs for employees, create value for investors or greater revenue opportunities for suppliers.
by Adam Hartung | Apr 1, 2014 | Current Affairs, Defend & Extend, In the Swamp, Leadership, Web/Tech
“Hope springs eternal in the human breast” (Alexander Pope)
As it does for most investors. People do not like to accept the notion that a business will lose relevancy, and its value will fall. Especially really big companies that are household brand names. Investors, like customers, prefer to think large, established companies will continue to be around, and even do well. It makes everyone feel better to have a optimistic attitude about large, entrenched organizations.
And with such optimism investors have cheered Microsoft for the last 15 months. After a decade of trading up and down around $26/share, Microsoft stock has made a significant upward move to $41 – a new decade-long high. This price has people excited Microsoft will reach the dot.com/internet boom high of $60 in 2000.
After discovering that Windows 8, and the Surface tablet, were nowhere near reaching sales expectations after Christmas 2012 – and that PC sales were declining faster than expected – investors were cheered in 2013 to hear that CEO Steve Ballmer would resign. After much speculation, insider Satya Nadella was named CEO, and he quickly made it clear he was refocusing the company on mobile and cloud. This started the analysts, and investors, on their recent optimistic bent.
CEO Nadella has cut the price of Windows by 70% in order to keep hardware manufacturers on Windows for lower cost machines, and he announced the company’s #1 sales and profit product – Office – was being released on iOS for iPad users. Investors are happy to see this action, as they hope that it will keep PC sales humming. Or at least slow the decline in sales while keeping manufacturers (like HP) in the Microsoft Windows fold. And investors are likewise hopeful that the long awaited Office announcement will mean booming sales of Office 365 for all those Apple products in the installed base.
But, there’s a lot more needed for Microsoft to succeed than these announcements. While Microsoft is the world’s #1 software company, it is still under considerable threat and its long-term viability remains unsure.
Windows is in a tough spot. After this price decline, Microsoft will need to increase sales volume by 2.5X to recoup lost profits. Meanwhile, Chrome laptops are considerably cheaper for customers and more profitable for manufacturers. And whether this price cut will have any impact on the decline in PC sales is unclear, as users are switching to mobile products for ease-of-use reasons that go far beyond price. Microsoft has taken an action to defend and extend its installed base of manufacturers who have been threatening to move, but the impact on profits is still likely to be negative and PC sales are still going to decline.
Meanwhile, the move to offer Office on iOS is clearly another offer to defend the installed Office marketplace, and unlikely to create a lot of incremental revenue and profit growth. The PC market has long been much bigger than tablets, and almost every PC had Office installed. Shrinking at 12-14% means a lot less Windows Office is being sold. And, In tablets iOS is not 100% of the market, as Android has substantial share. Offering Office on iOS reaches a lot of potential machines, but certainly not 100% as has been the case with PCs.
Further, while there are folks who look forward to running Office on an iOS device, Office is not without competition. Both Apple and Google offer competitive products to Office, and the price is free. For price sensitive users, both individuals and corporations, after 4 years of using competitive products it is by no means a given they all are ready to pay $60-$100 per device per year. Yes, there will be Office sales Microsoft did not previously have, but whether it will be large enough to cover the declining sales of Office on the PC is far from clear. And whether current pricing is viable is far, far from certain.
While these Microsoft products are the easiest for consumers to understand, Nadella’s move to make Microsoft successful in the mobile/cloud world requires succeeding with cloud products sold to corporations and software-as-service providers. Here Microsoft is late, and facing substantial competition as well.
Just last week Google cut the price of its Compute Engine cloud infrastructure (IaaS) platform and App Engine cloud app platform (PaaS) products 30-32%. Google cut the price of its Cloud Storage and BigQuery (big data analytics) services by 68% and 85% as it competes headlong for customers with Amazon. Amazon, which has the first-mover position and large customers including the U.S. federal government, cut prices within 24 hours for its EC2 cloud computing service by 30%, and for its S3 storage service by over 50%. Amazon also reduced prices on its RDS database service approximately 28%, and its Elasticache caching service by over 33%.
To remain competitive, Microsoft had to react this week by chopping prices on its Azure cloud computing products 27%-35%, reducing cloud storage pricing 44%-65%, and whacking prices on its Windows and Linux memory-intensive computing products 27%-35%. While these products have allowed the networking division formerly run by now CEO Nadella to be profitable, it will be increasingly difficult to maintain old profit levels on existing customers, and even a tougher problem to profitably steal share from the early cloud leaders – even as the market grows.
While optimism has grown for Microsoft fans, and the share price has moved distinctly higher, it is smart to look at other market leaders who obtained investor favorability, only to quickly lose it.
Blackberry was known as RIM (Research in Motion) in June, 2007 when the iPhone was launched. RIM was the market leader, a near monopoly in smart phones, and its stock was riding high at $70. In August, 2007, on the back of its dominant status, the stock split – and moved on to a split adjusted $140 by end of 2008. But by 2010, as competition with iOS and Android took its toll RIM was back to $80 (and below.) Today the rechristened company trades for $8.
Sears was once the country’s largest and most successful retailer. By 2004 much of the luster was coming off when KMart purchased the company and took its name, trading at only $20/share. Following great enthusiasm for a new CEO (Ed Lampert) investors flocked to the stock, sure it would take advantage of historical brands such as DieHard, Kenmore and Craftsman, plus leverage its substantial real estate asset base. By 2007 the stock had risen to $180 (a 9x gain.) But competition was taking its toll on Sears, despite its great legacy, and sales/store started to decline, total sales started declining and profits turned to losses which began to stretch into 20 straight quarters of negative numbers. Meanwhile, demand for retail space declined, and prices declined, cutting the value of those historical assets. By 2009 the stock had dropped back to $40, and still trades around that value today — as some wonder if Sears can avoid bankruptcy.
Best Buy was a tremendous success in its early years, grew quickly and built a loyal customer base as the #1 retail electronics purveyor. But streaming video and music decimated CD and DVD sales. On-line retailers took a huge bite out of consumer electronic sales. By January, 2013 the stock traded at $13. A change of CEO, and promises of new formats and store revitalization propped up optimism amongst investors and by November, 2014 the stock was at $44. However, market trends – which had been in place for several years – did not change and as store sales lagged the stock dropped, today trading at only $25.
Microsoft has a great legacy. It’s products were market leaders. But the market has shifted – substantially. So far new management has only shown incremental efforts to defend its historical business with product extensions – which are up against tremendous competition that in these new markets have a tremendous lead. Microsoft so far is still losing money in on-line and gaming (xBox) where it has lost almost all its top leadership since 2014 began and has been forced to re-organize. Nadella has yet to show any new products that will create new markets in order to “turn the tide” of sales and profits that are under threat of eventual extinction by ever-more-capable mobile products.
While optimism springs eternal long-term investors would be smart to be skeptical about this recent improvement in the stock price. Things could easily go from mediocre to worse in these extremely competitive global tech markets, leaving Microsoft optimists with broken dreams, broken hearts and broken portfolios.
Update: On April 2 Microsoft announced it is providing Windows for free to all manufacturers with a 9″ or smaller display. This is an action to help keep Microsoft competitive in the mobile marketplace – but it does little for Microsoft profitability. Android from Google may be free, but Google’s business is built on ad sales – not software sales – and that’s dramatically different from Microsoft that relies almost entirely on Windows and Office for its profitability
Update: April 3 CRN (Computer Reseller News) reviewed Office products for iOS – “We predict that once the novelty of “Office for iPad” wears off, companies will go back to relying on the humble, hard-working third parties building apps that are as stable, as handsome and far more capable than those of Redmond. It’s not that hard to do.”
by Adam Hartung | Jun 5, 2013 | Current Affairs, Defend & Extend, In the Whirlpool, Leadership, Web/Tech
Microsoft CEO Steve Ballmer appears to be planning a major reorganization. The apparent objective is to help the company move toward becoming a "devices and services company" as presented in the company's annual shareholder letter last October.
But, the question for investors is whether this is a crafty move that will help Microsoft launch renewed profitable growth, or is it leadership further confusing customers and analysts while leaving Microsoft languishing in stalled markets? After all, the shares are up some 31% the last 6 months and it is a good time to decide if an investor should buy, hold or sell.
There are a lot of things not going well for Microsoft right now.
Everyone knows PC sales have started dropping. IDC recently lowered its forecast for 2013 from a decline of 1.3% to negative 7.8%. The mobile market is already larger than PC sales, and IDC now expects tablet sales (excluding smartphones) will surpass PCs in 2015. Because the PC is Microsoft's "core" market – producing almost all the company's profitability – declining sales are not a good thing.
Microsoft hoped Windows 8 would reverse the trend. That has not happened. Unfortunately, ever since being launched Windows 8 has underperformed the horrific sales of Vista. Eight months into the new product it is selling at about half the rate Vista did back in 2007 – which was the worst launch in company history. Win8 still has fewer users than Vista, and at 4% share 1/10th the share of market leaders Windows 7 and XP.
Microsoft is launching an update to Windows 8, called Windows 8.1 or "blue." But rather than offering a slew of new features to please an admiring audience the release looks more like an early "fix" of things users simply don't like, such as bringing back the old "start" button. Reviewers aren't talking about how exciting the update is, but rather wondering if these admissions of poor initial design will slow conversion to tablets.
And tablets are still the market where Microsoft isn't – even if it did pioneer the product years before the iPad. Bloomberg reported that Microsoft has been forced to cut the price of RT. So far historical partners such as HP and HTC have shunned Windows tablets, leaving Acer the lone company putting out Windows a mini-tab, and Dell (itself struggling with its efforts to go private) the only company declaring a commitment to future products.
And whether it's too late for mobile Windows is very much a real question. At the last shareholder meeting Nokia's investors cried loud and hard for management to abandon its commitment to Microsoft in favor of returning to old operating systems or moving forward with Android. This many years into the game, and with the Google and Apple ecosystems so far in the lead, Microsoft needed a game changer if it was to grab substantial share. But Win 8 has not proven to be a game changer.
In an effort to develop its own e-reader market Microsoft dumped some $300million into Barnes & Noble's Nook last year. But the e-reader market is fast disappearing as it is overtaken by more general-purpose tablets such as the Kindle Fire. Yet, Microsoft appears to be pushing good money after bad by upping its investment by another $1B to buy the rest of Nook, apparently hoping to obtain enough content to keep the market alive when Barnes & Noble goes the way of Borders. But chasing content this late, behind Amazon, Apple and Google, is going to be much more costly than $1B – and an even lower probability than winning in hardware or software.
Then there's the new Microsoft Office. In late May Microsoft leadership hoped investors would be charmed to hear that 1M $99 subscriptions had been sold in 3.5 months. However, that was to an installed base of hundreds of millions of PCs – a less than thrilling adoption rate for such a widely used product. Companies that reached 1M subscribers from a standing (no installed base) start include Instagram in 2.5 months, Spotify in 5 months, Dropbox in 7 months and Facebook (which pioneered an entire new marketplace in Social) in only 10 months. One could have easily expected a much better launch for a product already so widely used, and offered at about a third the price of previous licenses.
A new xBox was launched on May 21st. Unfortunately, like all digital markets gaming is moving increasingly mobile, and consoles show all the signs of going the way of desktop computers. Microsoft hopes xBox can become the hub of the family room, but we're now in a market where a quarter of homes lead by people under 50 don't really use "the family room" any longer.
xBox might have had a future as an enterprise networking hub, but so far Kinnect has not even been marketed as a tool for business, and it has not yet incorporated the full network functionality (such as Skype) necessary to succeed at creating this new market against competitors like Cisco.
Thankfully, after more than a decade losing money, xBox reached break-even recently. However, margins are only 15%, compared to historical Microsoft margins of 60% in "core" products. It would take a major growth in gaming, plus a big market share gain, for Microsoft to hope to replace lost PC profits with xBox sales. Microsoft has alluded to xBox being the next iTunes, but lacking mobility, or any other game changer, it is very hard to see how that claim holds water.
The Microsoft re-org has highlighted 3 new divisions focused on servers and tools, Skype/Lync and xBox. What is to happen with the business which has driven three decades of Microsoft growth – operating systems and office software – is, well, unclear. How upping the focus on these three businesses, so late in the market cycle, and with such low profitability will re-invigorate Microsoft's value is, well, unclear.
In fact, given how Microsoft has historically made money it is wholly unclear what being a "devices and services" company means. And this re-organization does nothing to make it clear.
My past columns on Microsoft have led some commenters to call me a "Microsoft hater." That is not true. More apt would be to say I am a Microsoft bear. Its historical core market is shrinking, and Microsoft's leadership invested far too much developing new products for that market in hopes the decline would be delayed – which did not work. By trying to defend and extend the PC world Microsoft's leaders chose to ignore the growing mobile market (smartphones and tablets) until far too late – and with products which were not game changers.
Although Microsoft's leaders invested heavily in acquisitions and other markets (Skype, Nook, xBox recently) those very large investments came far too late, and did little to change markets in Microsoft's favor. None of these have created much excitement, and recently Rick Sherland at Nomura securities came out with a prediction that Microsoft might well sell the xBox division (a call I made in this column back in January.)
As consumers, suppliers and investors we like the idea of a near-monopoly. It gives us comfort to believe we can trust in a market leader to bring out new products upon which we can rely – and which will continue to make long-term profits. But, good as this feels, it has rarely been successful. Markets shift, and historical leaders fall as new competitors emerge; largely because the old leadership continues investing in what they know rather than shifting investments early into new markets.
This Microsoft reorganization appears to be rearranging the chairs on the Titanic. The mobile iceberg has slashed a huge gash in Microsoft's PC hull. Leadership keeps playing familiar songs, but the boat cannot float without those historical PC profits. Investors would be smart to flee in the lifeboat of recent share price gains.
