Time for Microsoft to Think Small

Microsoft (MSFT - Annual Report) is the third-largest company in the US by market cap (although 31 billion smaller today) and it is hard to turn around a tanker that big. So not surprisingly, when Microsoft issues news of yesterday’s nature there will be a wide range of interpretations.

Barry Ritholtz is not a fan of the products or the investment outlook. He likes the shares in the high teens or low $20’s and says:

From an investment perspective, there are 2 key issues to observe:
first, they are a mature company whose fast growth days are well behind
them. They are too big to be responsive, too expensive to be a value
stock, too slow growing to be a growth stock. In short, they are in the
process of morphing from the software PC leadership company to nice,
quiet, money machine. I would expect a good entry purchase (i.e., from
lower levels) could throw off gains of 10-15% a year, including

Paul Kedrosky soured on the name, calling Microsoft a Pig in a Poke. In his view, investing the windfall of simultaneous Windows and Office upgrades in less certain businesses is foolish. (We agree.)

Finally, a few choice quotes from the Reuters article:

“This effectively takes the wind out of the sails of
investor sentiment at a time when investors were beginning to
warm up to the prospects for accelerating earnings momentum,”
wrote Goldman Sachs analyst Rick Sherlund in a research note.

“If Microsoft can’t get operating leverage when it’s in its
biggest product cycle ever (and customer interest is high),
when can the company show leverage?” wrote Morgan Stanley
analyst Mary Meeker.

Microsoft can win back investor’s hearts by underspending the costs they have outlined, and by delivering on their promises. Dramatically reducing the capital employed in the business would also help. One thing investors may be overlooking in the current selloff is that if MSFT can successfully shift to a software-as-service business model there won’t be any more issue of whether Vista will be delivered on time. Operating system upgrades could take the form of small tweaks over time rather than a rushed, trimmed and delayed big package upgrade.

William Trent currently has a short position in put options related to Office Depot (ODP).

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