Wednesday, August 28, 2013

A Look At Microsoft Over the Ballmer Years

In the aftermath of Steve Ballmer's announcement that he will be retiring as CEO from Microsoft, it has been hard to find an article that judges his performance favorably.

Here, for example, is an excerpt from a short piece from the Harvard Business Review:

The business media lit up over the weekend with the news that Steve Ballmer, the college friend who worked alongside Bill Gates to build Microsoft and was heir to the CEO job, will step down within a year. Ballmer, whose skills were in many ways complementary to Gates', took the helm of an already massive organization as it entered an era of relentless disruptive innovation by competitors. He managed to hold the stock price on a pretty even keel, but no better than that....

It's worth taking a step back to look at what all the chatter is about.

The debate has focused almost entirely on the leadership of innovation.... There's a pattern in them. They argue over whether Bing was a respectable competitive response to Google or not; they give Xbox its due, while tending to cordon it off as a special case; they accuse Microsoft of being oblivious to the threat posed by Web and mobile apps, or point to evidence that it was responding. Ballmer is being damned or defended wholly on the string of innovative (or not) products released on his watch.

It is easy, I think, to criticize Ballmer for missing some of the changes in technology, but I wonder what many of his critics would have done in a similar situation?

Steve Jobs at Apple could afford to take a "bet the company" strategy when he returned to the helm because he really had no other option.  Before the iPod was introduced, most analysts believed the best days of the company were long gone.

The Windows franchise is dominant in the personal computing world, despite numerous efforts of other companies to unseat it.  Just try to send someone an email attachment from Apple's Numbers program, or Google documents, and see what the reaction will be.

Microsoft remains the third most valuable company in the S&P 500.   Yes, a number of Microsoft's products have landed with a thud on Ballmer's watch, but compare its performance to other tech companies in 1999.

When Ballmer took over, the bubble was in full swing.  Multiples on tech stocks were trading at nose-bleed levels. MSFT in 1999 was trading at a P/E of 80x, but this was actually a discount to the 200x Nasdaq multiple.

Consider the fate of other tech high-fliers from the start of 2000: AOL, Dell, Lucent, Sun, Hewlett-Packard, Motorola.  All have either crashed to earth, or gone out of business.

Here's an excerpt from today's New York Times:
Among Mr. Ballmer’s generation of tech executives, his post-2000 stock performance is hardly the worst. Shares of Cisco Systems, the biggest maker of computer networking equipment, have dropped 54 percent. Shares of Oracle, one of the biggest business software companies in the world, have fallen 30 percent. 

Dell, which is now trying to go private as part of a turnaround, is off about 70 percent. Sun Microsystems, once one of the most influential tech companies, was purchased by Oracle in 2010 for $5.6 billion, 88 percent below its value in 2000. 

Today MSFT trades at 12x, essentially in-line with Apple trades (12.5x), EMC (12x),  and Oracle (11x). Only Google (19x) has price/earnings multiple that is at a premium to the S&P. The bloom is clearly off the tech sector, at least as far as investors are concerned.

Put another way: if MSFT had the same earnings multiple as when Ballmer took over from Bill Gates, the stock would be at $240 a share versus $33.

So in order to judge Ballmer's performance, it seems to me, analysts should focus on Warren Buffett's favorite metric:  book value per share.

Under Ballmer's watch, the book value of Microsoft shares has risen from just under $4 per share to about $9.50 per share, or a compound growth rate of slightly less than 7% per annum.  Nothing special, perhaps, but better than many other large companies like General Electric (+6% per annum) or IBM (+2.5%).

The real problem Ballmer faced, and his successor will in future years, is nicely summed up by this quote from last weekend's New York Times:

Microsoft’s seeming strength, according to George F. Colony, the chief executive of Forrester Research, has proved a weakness. 

“I would argue Microsoft does have a financial problem, and it’s been the fear of losing those massive profits from Windows and Office,” Mr. Colony says. “By doing everything it can to try to protect those profits, Microsoft has taken a defensive position for more than a decade. And in technology, if you play defense you’re going to lose.” 

Still, thanks to the success of its mainstay businesses, Microsoft has been able to afford multibillion-dollar investments in newer fields like Internet search, digital media players, smartphone software and, recently, tablets. 

The problem for Microsoft has been that it has often been forced to make those investments while playing catch-up. In the search and smartphone markets, all the snowballing effects of leadership, brand recognition and consumer habits that helped Microsoft in the PC market are working against it as it tries to catch Google and Apple.