Wednesday, March 02, 2011

Is there hope for Microsoft?

I recently did a DCF on MSFT, and concluded that investors seem to undervalue the firm (disclosure, I do not own, but am considering a purchase of the stock). Either they have huge a huge discount rate (indicating high uncertainty), or they believe the company will not grow again.

Personally, I believe that rumors of Microsoft's demise are greatly exagerrated. The company is massively profitable, earns great returns on equity while having no net debt and maintaining mountains of cash. It has made some brilliant investments, and has seen the nexus between entertainment, mobile, and desktop software.

Moreover, it still controls the single best suite of productivity tools, and ensures that the various programs work well together. Even Apple had to cave (which is why they have moved toward hardware and the infrastructural software that operates that hardware).

Above all, Microsoft has generally proven that a fast follower is among the best technology strategies to have, particularly if you have mountains of cash you can deploy to get your version to market quickly. It means that you can avoid total write offs of technology ideas that have gone nowhere, of which there are quite a few. Often pioneers simply lack the resources to keep innovating, and a fast follower has the luxury of learning from the mistakes of the category creator, without the cost of adapting a set of code that already exists.

All of this is really to say that the idea that cloud computing and open source are about to kill MSFT's Office franchise seems really, really premature. Let's not forget that even in the 1980s when personal computing was a new-fangled rage, destined to change how we live and work, mainframes still did a thriving business. Desktop computing is not going away, and MSFT is likely to continue to dominate it.

It turns out that open source is quite expensive.

Firms and individuals may be less inclined to deal with the hassle and cost of maintaining integration of the various pieces. Sure, IBM can insist that "the future is open" - they make billions selling consulting services to help companies integrate their various IT platforms and to deploy "open source" solutions. It might be cheaper to pay the license fees than to pay staffs and consultants.

Indeed, even if the desktop business is destined for slow growth, might it not be the case that as the growth of the business slows, that returns actually improve? True, slow growth environments require discipline, but Microsoft has shown discipline in its capital deployment. Potentially slower innovation, as other "hotter" areas of the market get wads of cash thrown at them could mean that cashflows improve as CAPX declines as a share of revenue.

I am talking myelf into buying the stock, would appreciate some contrary feedback.

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