Buying Tech Stocks

I wrote last week about the difficulties of developing a winning investment strategy in technology stocks.  More examples can be found in recent news reports.

The pace of change in tech is, of course, astonishing.  Here for example is an excerpt from an article in this morning's New York Times about the incredible processing power that Amazon.com is now offering on a subscription basis through something they call "Amazon Web Services" (I added the emphasis):

...On Tuesday, a company appearing at the Amazon conference said it had run in 18 hours a project on Amazon’s cloud of computer servers that would have taken 264 years on a single server. 

The project, related to finding better materials for solar panels, cost $33,000, compared with an estimated $68 million to build and run a similar computer just a few years ago. Akin more to conventional supercomputing than {IBM's} Watson’s question-and-answer cognitive computing, the project was the first of several announced at the Amazon conference. 

“It’s now $90 an hour to rent 10,000 computers,” the equivalent of a giant machine that would cost $4.4 million, said Jason Stowe, the chief executive of Cycle Computing, the company that did the Amazon supercomputing exercise, and whose clients include The Hartford, Novartis, and Johnson & Johnson. “Soon smart people will be renting a conference room to do some supercomputing.” 

http://www.nytimes.com/2013/11/14/technology/ibm-to-announce-more-powerful-watson-via-the-internet.html?ref=business 

Little wonder, then, that the most valuable companies in the technology area that have little or no profitability, murky revenue outlooks, yet are offering users capabilities that few thought available just a few years ago (e.g. Twitter).

Still, it is almost mind-boggling to see the young entrepreneurs who started the instant message service Snapchat turn down $3 billion from Facebook.

While Snapchat is hugely popular among millenniums,  the company has no revenue or profits.  Moreover, it is not clear how they will be able to monetize its current popularity:

What business makes no money, has yet to pass its third anniversary and just turned down an offer worth billions of dollars? Snapchat, a social media service run by a pair of 20-somethings who until last month worked out of a beachfront bungalow in Venice, Calif...

The service, started in 2011 by Evan Spiegel, 23, and Bobby Murphy, 25, two former Stanford fraternity brothers, lets users send photo and video messages that disappear after they are viewed. Snapchat quickly gained a reputation as an easy way to send sexually suggestive photos, but it also picked up steam as a fun and easy way to trade photo messages. 

The company has in recent months become one of the most sought-after businesses in the tech industry, getting attention from top Silicon Valley companies and venture capital firms, as well as international technology companies. 

http://www.nytimes.com/2013/11/14/technology/rejecting-billions-snapchat-expects-a-better-offer.html?hp&_r=0 

Interestingly, Fortune magazine's technology columnist Dan Primack thinks that Snapchat was right to turn down a multi-billion dollar payday:

Facebook's original offer was said to be for between $1 billion and $2 billion, but today the WSJ is reporting that Zuckerberg later raised the stakes to $3 billion. And was still rebuffed!

At first blush, it seems ridiculous. A pre-revenue company founded less than three years ago turns down a deal that would value it at 3X what either Instagram or Tumblr got...

...Snapchat and its investors seem to believe that this company is the next generation of social networking -- not an add-on to the dominant incumbent. Snapchat is about immediate/disposable communication, not permanent record-keeping...

In other words, Snapchat is providing its users exactly what existing services like Facebook and Twitter and Tumble are not. Not surprisingly, some people close to the company say that Snapchat's depth of engagement is off the charts. Sure the core technology itself is fairly simple. So is Twitter's (TWTR) -- a company that also wasn't monetizing 2.5 years into its existence.

http://finance.fortune.cnn.com/2013/11/13/snapchat-crazy-facebook/?iid=SF_F_River

Meanwhile, back in "old" tcch, companies like IBM, Oracle and Microsoft are trading at multi-decade lows.  Here's JP Morgan strategist Thomas Lee as quoted on CNBC:

{Lee} sees opportunities in low PE, mega-cap tech names like Microsoft, IBM, Cisco Systems, Oracle, EMC, even Hewlett-Packard—saying more than half the group are "under 12 [times earnings]." 

"It reminds of the pharma trade a few years ago. People looked at these low multiples, these cliffs, and thought it wasn't worth buying. And then they were great stocks," he said. 

http://www.cnbc.com/id/101190119

In other words, the current winners in the tech space seem to be inversely correlated with profitability.

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.

http://blogs.hbr.org/hbr/hbreditors/2013/08/steve_ballmers_big_lesson_innovation.html

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 dot.com 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. 

http://www.nytimes.com/2013/08/26/technology/young-tech-sees-itself-in-microsofts-ballmer.html?pagewanted=2&src=recg 

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. 

http://www.nytimes.com/2013/08/25/technology/needed-at-microsoft-a-catch-up-artist.html?pagewanted=all&_r=1& 

My Favorite Steve Ballmer Story

A great deal has been written about Microsoft CEO Steve Ballmer in the wake of his retirement announcement last week.


Lost in these articles is the crucial role that Ballmer played in creating Microsoft. When Gates, Allen, Ballmer, et.al. started the company, they shared a single dream of a world connected by personal computers (PC) that would be easily accessed by anyone, even those lacking in technology skills.

While you can argue that some of its products are not particularly user-friendly, Microsoft changed the world, and not too many companies can make that claim.

The story of Microsoft, and other tech giants, is beautifully told in a book titled Accidental Empires: How the Boys of Silicon Valley Make Their Millions, Battle Foreign Competition, and Still Can't Get A Date.  Written by Robert Cringely, the book later became the basis for a television series on PBS called "Triumph of the Nerds".

 http://www.amazon.com/Accidental-Empires-Silicon-Millions-Competition/dp/0887308554/ref=sr_1_1?ie=UTF8&qid=1377608162&sr=8-1&keywords=robert+cringely

Even though the book is fairly dated (it was first published in the early 1990's), I still think it is one of the best in its genre in capturing the spirit of the tech industry in Silicon Valley.

Which brings me to my favorite Steve Ballmer story.

Here's the excerpt from Cringely's book:

The Age of Microsoft dates, I believe, from a moment in 1989 when executive vice-president Steve Ballmer borrowed some money. Prior to that moment, Microsoft had all the elements necessary for global digital dominance except the will to make it happen. Ballmer's mortgage signified that there was finally a will to go with the way.

Ballmer's was Bill Gates's Harvard buddy, and Microsoft's twentieth employee.When Ballmer joined Microsoft in those early days, he didn't even have an office, but was granted space at one end of the sofa near Bill's desk.  Ballmer, a former brand manager at Procter & Gamble, represented Microsoft's new business orientation, an orientation that surged after 1989. By that year, just as Bill had, he came to the blinding realization that IBM no longer controlled the PC business - Microsoft did....

So Ballmer took a chance.  He borrowed everything he could against his Microsoft stock, stock options, and his every other possession.  In all, Ballmer was able to borrow $50 million and he used every cent to buy more Microsoft shares....Ballmer was betting his entire fortune on Microsoft. This is the only instance I can recall of such behavior.

There's something about betting every penny you have in the world that helps with focus, and Microsoft has been very focused during the 1990s. As a result, Steve Ballmer is now Microsoft's third billionaire, joining Bill Gates and Paul Allen.

A different side of Steve Ballmer, perhaps, than you have heard about recently.

What to do with Microsoft?

The blog Business Insider carried a good piece about Microsoft today.

It's hard to remember, but it was only 15 years ago the Federal Government brought a antitrust lawsuit against Microsoft. 

While ultimately the company prevailed, and Microsoft was not broken up as the government attorneys had sought, the dominance of Microsoft and its Windows operating system was widely acknowledged in the late 1990's, and most technology work at the time was done with an eye to working with Microsoft software.

Today, personal computer sales are plummeting. Michael Dell is attempting to take his company private at a price that is only a fraction of where Dell trading five years ago. Other personal computer manufacturers are trying to decide whether to exit the business.

As the technology world focuses its attention on mobile applications, Microsoft is facing a number of challenges in the coming years.

This is not to say the company is disappearing. Recently, for example, it introduced a new version of X Box, which has apparently stolen a march on Apple as it offers consumers a variety of new ways to watch television. 

Microsoft's dominance in the corporate world remains unchallenged; just try to email a document or spreadsheet that is not formatted in either Word or Excel. Every year the company receives a tidal wave of royalty fees which allows it to work on new products.

The stock has been strong this year, as the above chart indicates, rising more than double the S&P 500. Whether it is because the company pays a healthy 2.5% dividend from its $63 billion (!) cash hoard, or because investors are believing that the company is on the verge of delivering new important products for mobile, is a subject for debate.

But it seems likely that Microsoft's business mix will be much different that it is today.

Here's an excerpt from the Business Insider post:

Microsoft's "Windows monopoly" hasn't been so much destroyed as rendered irrelevant. Thanks to the explosion of Internet-based cloud computing and smartphones, tablets, and other mobile gadgets, the once all-powerful platform of the desktop operating system has now been reduced to little more than a device driver. As long as your gadget can connect to the Internet and run some apps, it doesn't matter what operating system you use.

Read more: http://www.businessinsider.com/windows-monopoly-is-getting-destroyed-2013-7#ixzz2ZJWPQ3en

And the most interesting chart from Business Insider that illustrates how quickly the personal computer world is changing: