Life Without Microsoft

Three weeks ago, when we were up 28% in Microsoft (MSFT), I wrote:

To be blunt, this stock has not lived up to my forecasts. Four-and-a-half years of ownership have produced returns far below what could have been achieved in a plain index fund, much less a high-powered strategy like our permanent portfolios.

A $10,000 investment in MSFT in August 2002 is today worth $12,800. A $10,000 investment in our Maximum Midcap strategy in December 2002 is today worth $30,537.

I mentioned that CEO Steve Ballmer has not lived up to expectations, and that his pronouncement that sales projections for Vista were overly aggressive was worrisome. I dug deeper into that and found that Microsoft had changed the way it was accounting for operating system sales, and placed some of the blame on that.

Too, perhaps Microsoft was keeping expectations low in order to surprise on the upside later. That’s what Merrill Lynch thinks, as analyst Kash Rangan made clear. “We think management is being conservative at the start of the product cycle,” he wrote. Merrill reiterated its buy rating and its $33 price target, implying at least 21% appreciation potential from Friday’s close.

Since that article, more sales reports have come in. Vista is not looking good. Cowen’s Louis Miscioscia wrote on Friday:

After a series of store and channel checks, we believe that Vista optimists will continue to be disappointed by the pace of PC sales post launch. After the consumer release on 1/30, retail PC sales were clearly well above seasonal norms during the first two weeks. But the surge proved temporary, and demand trends returned to more normal levels by the end of February. The lack of follow-through excitement suggests that consensus [estimates] for PC growth in [the first half] are at risk.

I was among those Vista optimists, and the release of the new OS has been a guiding theme for some of The Kelly Letter’s individual positions for a little more than a year now. It played a part in our holding Microsoft longer, of course, but also in our buying our semiconductor equipment maker, our computer maker, our semiconductor maker, and our security software publisher. With the exception of the security software publisher, all have been slow. The fault in each case is not entirely Vista’s, but some of it is. Each company faces its own challenges independent of Vista, but Vista’s unremarkable debut has not helped.

I’ve been thinking about this a lot recently. The timing has been interesting because I began last fall an upgrade of my office that’s still going on today.

I chose new equipment from Hewlett-Packard (HPQ) along default software configurations, which were Windows XP with the usual Office suite from Microsoft and Internet Explorer.

What a nightmare it’s been. Migrating all of my company’s data to the new equipment took forever because re-installing introduces new settings. Then came the inevitable DLL errors, corrupted data file errors, missing drivers, and the host of difficulties that all PC users know all too well. We needed to completely wipe a new hard drive and reinstall everything twice, were on tech support to India for hours, and then with HP USA for hours on a different occasion.

One night, while lying in bed, I stared at the ceiling after a completely unproductive day of chasing down computer problems. I thought back over my history of using computers in college, then at IBM, then in my own business. It’s always been this way, I realized. I’ve always had to spend about 10% of my time fighting the equipment that’s supposed to make life more productive.

Call the PC maker’s tech support and they tell you to call Microsoft. Call Microsoft and they tell you that you’ll need to call your PC maker, or the maker of some other software on your computer. Tech support, essentially, doesn’t exist beyond being a marketing point to get you to buy. For instance, HP’s tech support is a J.D. Power and Associates certified provider, yet they were utterly ineffective at solving even one of the issues faced in my relatively uncomplicated office.

Bottom line: in computing, you’re on your own.

The advent of the internet has changed things dramatically. Over the years, I’ve moved more and more of my business online for safety. My goal was to set up my business so that if my office burned down, or all of my computers were stolen, I could still operate. I have accomplished that. My databases are online, my banking is online, my portfolio is managed online, my notes like this one are saved online, and so on.

On any computer connected to the internet, I can run my business. I could stop by your house tonight and, if you’d let me, sit down at your computer to conduct research and compose a note to Kelly Letter subscribers, then send it from right there. Even if you use a Macintosh, Sparc Station, or Linux machine, I could do it.

I’m not the only person in this position. Lots of people have made themselves machine independent. As Sun has said for years, “The network IS the computer.”

How does this relate to Microsoft? Only anecdotally at the moment, but importantly. I have vowed that, from now on, my office will use only open source, freely available software whenever possible. I am no longer tied to proprietary formats such as Microsoft Word, Microsoft Excel, and so on. Internet Explorer is pathetic next to freebies Firefox and Opera anyway, so that switch is an easy one. Why use Outlook Express when you can use Thunderbird? It’s free and better.

I’m also experimenting with the Linux operating system, which is free and, I’m told, better than Windows. A life without blue screen errors is the life for me.

Recently, Dell (DELL) introduced a new customer feedback forum on its website as part of its restructuring efforts. More than 100,000 people asked the company to offer Linux as an alternative to Windows. HP says that it, too, is preparing to offer Linux. One Chinese customer ordered 30,000 Linux laptops.

I wrote last September 9 that Google’s (GOOG) free hosted software was not a threat to Microsoft Office. At that time, “Google Apps for your Domain” was clumsy and hard to use. In just six months, Google has made tremendous progress to the point that I signed up my company for its premium service this week.

For just $50 per user per year, all of my team can access all of our documents at and edit them online anywhere in the world. It took fifteen minutes to set up. There were no downloads. No data backups. No upgrade hassles. No DLL errors. No corrupt files.

Soon, Jason Kelly & Co. will be running Linux, browsing the web with Firefox, checking email with Thunderbird, creating documents with free editors or Google Apps, maintaining websites with free HTML editors, hosting databases at AWeber, collecting payments with PayPal, banking online, and hosting websites at ICDSoft.

Not one of those activities cares what computer I use to get it done. Not one cares where I am. The operating system is irrelevant.

In short, Microsoft is no longer part of my life, I’m saving money, I’m more productive, and my customers haven’t noticed one iota of difference.

All of which comes back to Microsoft as an investment. I would not say that it’s over yet. My experience is not representative of Microsoft’s core market, which consists of major corporations buying thousands of licenses.

However, my experience is relevant. If I can go non-Microsoft, so can you. If we can do it, so can other people. If they can
do it, so can a bigger group. It begins like that. What corporation would choose $300 per user over $50? What company would rather pay an IT service department to handle data back-ups and upgrades than have Google do it for free? What organization would prefer waiting for years to get an expensive upgrade from Microsoft when it can get frequent, free upgrades from open-source developers?

I’m not pounding the table for Google Apps. I’ve just started using it. There are problems. It’s not as full-featured as Office. Then again, most of Office’s advanced features are never even known, much less used, by its users. Also, why pay even $50 for Google Apps when Open Office is completely free and quite good?

Beyond office applications, though, it’s clear that corporations are already onto the non-Microsoft theme. Linux is spreading. Firefox is spreading. Alternatives are more viable than they’ve ever been.

What is Microsoft doing? Not much beyond its core Windows/Office cash cow. It has not been able to beat Google and Yahoo (YHOO) in the search advertising game. It makes software that runs on corporate computers and web servers that could keep getting business for quite some time, but in that realm dominated by savvy tech users, all kinds of alternatives exist. My web server, for example, runs on Apache and uses PHP scripting. Both are open source.

Finally, I want to share with you a note I received this week from long-time subscriber Ron, who is a Microsoft Certified Trainer, Microsoft Certified Technology Specialist, Microsoft Certified Professional Developer, Microsoft Certified Systems Engineer, among other Microsoft Certified designations. Here’s a guy who knows a lot about Microsoft, and he wrote:

I work as an Enterprise IT consultant around the U.S. for large corporations. I have been casually surveying them and asking if they plan on upgrading to Vista. The answer is no. Not now and not until they are forced to upgrade as XP SP2 is stable and meets their needs. In today’s market, the buzz phrase is “good enough computing” probably because all the blarney has come home to roost.

Then today I went to my favorite supplier and was buying some parts and asked about Vista and how they were doing on new laptop sales. He said candidly that it has been a disaster for them because the PCs go out the door then the users get them back to the office or home and there are so many hardware compatibility issues that they bring them back and demand a refund. He said they are literally falling off the return shelves and stacked ceiling high.

Ron’s field report is consistent with press reports on Vista and analyst projections on PC sales. It looks like I’m not the only one whose computing needs have stabilized and who’s future plans don’t include Vista. I appreciate Ron’s taking the time to send his report, and gave him two free months of The Kelly Letter.

This trend of not needing Microsoft’s products is an important if nascent one. Long-term investors should examine it carefully.

If you have an existing position in the company, I would hold a while longer. Microsoft should improve in the medium term. Here’s why:

  • Sales and earnings are going to get a big boost as the deferred revenue from Vista and Office 2007 get booked this quarter.
  • Vista is pretty and offers improved security. Those factors plus compatibility issues will see that both it and Office enjoy steady if not stellar demand.
  • Microsoft is getting better at its Xbox game business, its online offerings, its new Zune player, and other initiatives.
  • By P/E ratio, Microsoft shares are the cheapest they’ve been since 1990.

Those points will provide medium-term performance, but I have doubts about Microsoft’s long-term prospects. It’s a company with a smart history, but we need to see a lot more innovation and getting-with-the times to feel comfortable with it for the long haul.

As long as it remains a Dow component, Microsoft will be part of The Kelly Letter via our Double The Dow strategy. As an individual position, however, Microsoft must show some improving business prospects to keep its place.

To read subscriber follow-up to this article, click here.

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