Microsoft – an accounting geek’s summarizes his purpose and lessons

This is not a post with investment conclusions.  It is more a little about my own voyage.  If you want the stock posts read the last two posts in order.

My purpose

The purpose of this blog (as stated in my profile) is:

to explore investment ideas. [This blog] differs from most investing blogs as I have no intention of talking my own book. However I will explore what is wrong with my investments and that means I need to talk about positives and negatives. I welcome criticism. I most value criticism which demonstrates that some of my ideas are wrong.

I wrote the post to try and explore what was wrong with Microsoft stock (which – for the record I own in small quantity).  I was slightly annoyed with the title put on the post when it was reprinted by Business Insider because it misrepresented my purpose.  That said – there are real negatives with the Microsoft story – and it is worth exploring them. 

Microsoft is (way) outside my usual beat.  I am an accounting geek.  I like to read accounts to find out where things have been clipped, where the statements are aggressive, where the bodies are buried. 

Microsoft is an unusual company because there are no bodies buried in the accounts.  The business is staggeringly profitable – and those profits are entirely visible in cash (and equivalents).  Usually I add value (if I manage to add it at all) by understanding how the business makes its money and how that is reflected in their accounts.  For me reading Microsoft’s accounts beyond a summary and cash flow statement is pointless.

With a complex financial institution (my usual beat) understanding the accounts can be a difficult job.  Schiff’s Insurance Observer still refers to “the blonde with more curves than Conseco’s financial statements”.  Microsoft’s statements are as curvy as Bill Gates.  This is a fabulous business – arguably the best business in the history of capitalism. 

So the question:

The outcome for Microsoft stock will be driven by whether – in ten years – we wake up and find that Microsoft has retained dominance in the way corporations interact with their data and a decent position in the relationship of retail consumers and digital data. 

If Microsoft is dominant in that they will be making much more money in a decade because there will be much more information – and more computers - and the cost-per-computer is not outrageous even if the total revenue line is. 

If Microsoft loses its dominance then the stock could have another weak decade (notwithstanding the fact that it starts at a low price relative to current cash flow).  The stock price is so low relative to indisputable current cash flows that Microsoft would really have to stuff it up from here to make the stock a worse investment than say the current ten year bond.  But this is technology and it is subject to rapid change.

In my semi-geeky way I tried to run through the threats to understand them.  The threats are obvious: virtualization (and hence the end of the hardware-dependent computer), virtualization (and hence the end of the client-server model Microsoft rode to glory), Linux (and free software generally), the resurgence of the Macintosh platform, and (possibly most importantly and certainly most obviously) the increase in (mostly non-Microsoft) mobile devices (which are increasingly how the young and the affluent consumer relates to music and the internet and to data generally). 

So far – with respect to most of those threats – Microsoft has not been victorious – but has left itself a place at the table.  Even Zune has a place at the table even if it is up the end... 

Microsoft has not had an unambiguous winner in a decade – but then they are so entrenched that even without a winner they remain a strong company.  They produced one (very) weak flagship product (Vista).  But they have a (very) good product now (Windows 7) – it is however sufficiently late to cede a lot of ground to Apple.  Still you could imagine a world with an absolutely brilliant Windows 10 (!) phone which integrates near perfectly with business data (being a thin client for the work computer) but also has a lossless music player, high quality music jacks, integrates with Facebook (or its successor) perfectly – oh – and it is as cool as any future iPhone.  It just has not happened yet – but a super-hot product would add 100 billion to the cumulative cash flow Microsoft might produce and make the stock a fabulous investment.

On virtualization the “clients” in my experience are mostly windows (or often virtualized windows servers sitting on linux boxes).  Microsoft has a position.  But the virtualization platforms are Citrix, VMWare and others.  The underlying operating system is linux.  Indeed Wikipedia gives a huge list of programs and Windows is by no means dominant.  Linux (outside the server market) remains a product for geeks and Baltic grandmothers (but is getting better rapidly).  Apple look like the winner in mobile devices – but it is early in that game still and I think Linux in its Android form is likely to wind up the winner just because Apple extracts too much margin and the Android product is likely to be just as good (except for the killer iPod app).  That said the Windows 7 phone reviews pretty well.  Ten years ago Palm was the likely winner in mobile devices.  These things change!

A comment on the comments

The comments were very high quality. Sure I found someone who believed that Linux must run on top of (pirated) Windows XP.  He simply could not believe that you could run a computer without Windows.  [That level of ignorance is itself interesting because it tells you just how entrenched Microsoft is…]  But I also found down-in-the-trenches people who could not imagine that any business could go all thin client.  [I observed however that quite sophisticated businesses have gone that way already – and it is far superior to the client-server arrangement for security and disaster recovery – but not only is it superior – it is cheaper.]   I found religious open-source zealots but also entirely practical people who thought you could not get fired for buying Microsoft.  (I noted that in the server business for many applications you would be fired for buying Microsoft…) 

I met open-source geeks who thought that Ubuntu – at its current rate of improvement – would be as user friendly as a Mac within 12 months.  That is aggressive. It took me considerable effort to permanently mount the windows-share hard drives on my new computer – enough difficulty that I can be sure Ubuntu is not ready for prime time.  But given the improvement between my first linux machine [a Mandriva 2006 release] and the current Ubuntu release I think Ubuntu will be up to it in a few years.  That said the Mac is more user friendly than Windows and it has not won the war at corporate level.  The better product does not necessarily win because of the advantages of incumbency.   

A comment on the stock selection

This a long way outside my circle of competence.  I reckon I can read a bank’s financial account as well as anybody – but nothing is added by reading Microsoft’s accounts.  So to do this I had to become more geeky than is natural for me.  Alas I discovered there is as much debate amongst geeks as there is debate amongst bank analysts and – like bank analysts – they are probably all wrong about most things. 

I really want to thank everyone who commented.

 

John