Further Evaluation of Steve Ballmer

Last Friday’s article on Steve Ballmer being bad for Microsoft generated a lot of reader commentary.

Jack wrote:

I disagree with your position on Ballmer. The reasons being:

• Ballmer took control over Microsoft whilst it was at a huge premium to intrinsic value. Despite improving value of the business it was not enough to substantiate the large equity premium on top of intrinsic value. At current prices, this may not be the case.

• Ballmer has grown the company considerably over the last few years (earnings + revenue wise), drawing attention to many value investors as you mentioned in your article. If you look at this website, it shows that Einhorn, Tweedy Browne, etc. have large holdings in the company. These investors are not to be underestimated.

• After eight or so years with Ballmer at the helm of Microsoft there seems to be no significant erosion of Microsoft’s economic moat. In fact their dominance in operating system software has extended to Mac, as I for one, like many others, install Windows on my Mac. Products such as Vista and Office are continuing to be a “necessity” on one’s computer. Although OpenOffice and Google Docs have their merits, they are not very compatible with Office (sometimes the fonts get mucked up, etc.), further…try loading an ODS file on Office! Although Firefox has cut down Internet Explorer market share, that in turn has never been a material source of Microsoft revenue.

• Microsoft gaming is experiencing huge growth. It currently makes up 11% of revenue, yet grew 68% last quarter. By next year I’m guessing that this division will grow up to 16% of revenue. Vista is experiencing large growth as well.

At a forward P/E of 13 and with significant levels of cash (they special dividended a fair bit!), the company may be undervalued. Ballmer has undoubtedly built up the intrinsic value of the business and for a true value investor, that is what it is all about.

Jack raises excellent points, some of which I hinted at last week. It’s true that both revenue and earnings have grown on Mr. Ballmer’s watch. Gaming has also flourished while he’s been at the helm.

The question is: Why haven’t rising earnings and revenue translated into a higher share price? The lack of capital appreciation means that investors dislike something at Microsoft.

Jack and others pointed out that it may not be fair to compare the price of MSFT in early 2000 with its price today because the early 2000 price came at the tail end of the internet bubble and all technology stocks were overinflated. However, even if we start examining the stock from the beginning of 2003 when the crash was over it fails to impress. MSFT began 2003 at around $28 and closed yesterday at $27.71.

It paid dividends, true, but that’s hardly a compelling reason to own the stock. Its dividend yield is 1.6%. There are better stocks for dividend income, such as Pfizer with a yield of 7%.

In any event, it’s clear that the market has paid a lower multiple on Microsoft’s growing earnings, resulting in a flat stock over the past five years, during which time Mr. Ballmer has been in charge. Again, why is that?

My take is that investors are finding better futures elsewhere. Outside of gaming, what new territory has Microsoft claimed? It still puts out Windows and Office, and has improved their capabilities in marginal ways. Jack pointed out that he installs Windows on his Mac. That’s not much of a growth story, though.

What I think Microsoft needs is another huge market to call its own. Per its usual approach, it has refused to invent anything or revolutionize any process. It’s finding that its usual mode of copying and outmarketing the creator is not working online. Google has used the network effect to nullify Microsoft’s strategy. Microsoft can copy Google all it wants, but there’s no compelling reason for people to switch from Google to Microsoft, so the copycat sits lonely while the pioneer is overrun with users.

The ample cash that Microsoft has is apparently earmarked to buy Yahoo in a last ditch attempt to catch up with Google. Here again, what a head shaker. Buying Yahoo is Microsoft’s internet strategy? That’s some visionary leadership from Mr. Ballmer. It was not this kind of behind-the-curve reactive management that made Microsoft the wealth machine that it used to be.

In retrospect, it seems that making internet search faster and more accurate was an easy goal to have seen back around 2000. You may feel that rearview analysis is easy, but remember that Microsoft takes every opportunity to boast about its technology gurus and skillful team. Well, if they’re such gurus and so skillful, why didn’t they come up with something we’ve needed in the past eight years? It’s a fair question. I haven’t needed even one upgrade from Microsoft. Have you? I don’t use Office to create new documents, and when somebody sends me an Office document I open it with an old version of the software. I never even considered upgrading to Vista. Did you?

Meanwhile, my personal life and business are increasingly run with Web 2.0 applications accessed by Firefox. Our next office upgrade will be to all Apple products, not because they bring capabilities that we can’t live without but because it finally doesn’t matter what machines and local software we use. Everything happens online anyway, so any machine can do the job, so why not go with the best ones? In our opinion, the best computers are made by Apple.

When we work with a new organization, we suggest that they coordinate with us easily by using Google Docs. Most are now already familiar with it — which is pretty impressive in itself — and those who are not have no trouble getting up to speed. Once they see that sharing information is as easy as logging into Google Docs and checking the file that we can all access, there’s never a complaint. “Sure beats email attachments,” is a typical comment.

In short, I think the market sees Microsoft losing its grip on computer users and having nothing to take its place when those users start leaving. Jack’s right that they haven’t started leaving in droves yet, but the market is a forward looking mechanism and senses that at Microsoft there’s a greater chance of ramping down than ramping up.

If that’s not what’s going on, then what else? A long-term stock chart shows Microsoft stock forming a plateau after Mr. Ballmer took over. Something, caused its stock to lose relative appeal. The above reason is my best guess.

 I’ve looked just at the stock’s performance when pointing a finger at Mr. Ballmer. Other readers have looked more closely at the man. Charles sent the following clips and wrote that it’s “scary” to think of how many people are depending on this guy: