Thursday, June 09, 2011

A good take on MSFT

Insider Monkey has the complete transcript of David Einhorn at the Ira Sohn conference, in which he picks MSFT as a long, and explains the overhang in the stock.

Like Einhorn, I believe that MSFT is just ridiculously cheap.  Given the fact that many cloud businesses are trading at 10x revenues (with few or no discernable profits), MSFT, which trades at 10x earnings, is a bargain.

Einhorn's view - that the big risk is not that earnings will suddenly evaporate when the iPad kills the laptop (this is Street fancy compounded by the need to make aggressive predictions if you want to appear reguarly on CNBC), but rather that Steve Ballmer and the management team will reinvest those earnings poorly is exactly right.  Unfortunately, we have received another sad example of this with the insane valuation MSFT paid for Skype.

Of course, people don't own tech for value - they own it for momentum and huge operating leverage - and without big growth prospects, MSFT cannot attract growth investors, and as a tech company - particularly one with huge amounts of outstanding shares, it cannot attract value investors, or at least not enough value investors to help the share price.  But this means that the best investment MSFT can likely make is in its own future cashflows from Windows - by repurchasing shares.

Sure, you can argue that they already do this - and they have made a significant reduction in shares outstanding.  Moroever, they have finally reached the end of the stock options issued to employees, so equity conversion will no longer be a drag on net repurchases.  But there is no reason they cannot continue or even consider accelerating repurchases.

Plus, if they were to dump the online search business, which has been a perennial loser, they could convert a $2.5B drag on earnings ($0.28 per share before tax) into a one time gain - potentially as equity in a complementary business.  Personally, I like Einhorn's suggestion that MSFT sell Bing to Facebook for equity in Facebook, but I digress. With the savings, they could raise the dividend again to become that much more attractive to value investors and the rising tide of Baby Boomer retirees, who need to figure out how to invest their 401(k)s for the next several decades.  This would be almost a "free" dividend hike, since it would not reduce after-dividend cash flows - meaning that R&D could continue apace, and MSFT would hold out the attraction of being able to raise a solid dividend at a rate faster than inflation, a retirees' dream: a rising standard of living in retirement!  As a very liquid stock, this could create a large bulk of "permanent" capital held by long term investors.

But, Ballmer is well on his way to being the largest individual shareholder, as Gates continues to whittle down his direct holdings, so the likelihood that he will be ousted is small.  Even so, I believe that MSFT can be a $34 stock at virtually any moment.  In the meantime, I can collect my dividend and wait, while the company continues to by $34 dollar bills at $24, giving me an immediate 30% return on repurchases.  I also reinvest my dividends.

[UPDATE]: I think I also want to look at this insurance company Einhorn mentions.  The numbers are simply amazing.