Microsoft: In Need of Focus

Microsoft’s financial analyst meeting was a tale of a technology conglomerate: You heard a lot about search, a decent bit about the enterprise and all sorts of projects in between.

But amid all the coverage–see Mary Jo’s laundry list of stories–I can’t help but wonder if Microsoft’s various ventures aren’t diversions that take away from the real profit potential of the enterprise business.

Instead of chasing Yahoo, plotting to be an advertising empire and pining for consumers with things like the Xbox and Zune perhaps what Microsoft really needs is an IBM moment of clarity. Remember IBM (IBM)? Big Blue used to do everything too, but then it suddenly got it. IBM unloaded its PC business to Lenovo and started focusing on the two things that were insanely profitable: Software and services. Oh yeah, the hardware is still there too, but IBM is all about enterprise and helping business get stuff done.

IBM’s public persona may have taken a hit with the average consumer–it’s not like Tivoli, Rational and IT services are discussed at picnics–but there’s no question it made the right move. IBM is more profitable than ever. And it’s focused.

Microsoft could use some of that focus. It’s not that Microsoft is forgetting the enterprise business. In fact, Microsoft is hellbent on being the No. 1 enterprise software company. The problem: That enterprise windfall is funding things like Live Search and Xbox. I credit Microsoft for its willingness to invest and be tenacious, but you have to wonder about the returns here.

The bridge from Windows to becoming an enterprise company made more sense. Listen to Microsoft’s online media ambitions for a while and you can’t help but wonder if the DNA is there to succeed. As you mull over all the Microsoft presentations one thing sticks out: Execs talked about the enterprise and came across as authentic. The ad-search-consumer pitches were missing something–an institutional knowledge if you will. Microsoft is a software company not a media property.

And it’s not like the enterprise thing is lacking opportunity. It’s not a stretch to see Microsoft punching Oracle (ORCL) and SAP (SAP) in the mouth at some point. Microsoft is a big enterprise application player in smaller and mid-sized businesses. Those businesses tend to grow up to be big enterprises. If Microsoft apps grow up with enterprises Oracle and SAP may not have the lock they have always enjoyed.

In Ballmer’s presentation he said:

We see the most fantastic growth opportunities of all time in the enterprise. Desktop value, mail and collaboration, business intelligence, business applications, the server market despite virtualization is still exploding, enterprise search, the move of enterprises to host their infrastructure in the cloud that we call Microsoft Online, conferencing and IP telephony, management, virtualization software, the database and database application platform. I think palpably we are about this close, Microsoft, able to claim that we’re the number one enterprise software company in the world, which nobody would have been able to say 20 years ago, and yet we see nothing but opportunity.

Why shouldn’t Ballmer be enthusiastic about the enterprise? Look at this lineup:

Take that lineup and hook it up to the cloud and you have the future.

And guess what? Ads aren’t going to support the enterprise business–or Windows for that matter–so how critical is chasing Google (GOOG)?

Naturally, Ballmer went back to yapping about Live Search and talking ads. Ballmer’s overriding message was that Microsoft is prepared to tackle technology shifts–and the biggest one is the Internet and how everything will be connected via services.

Ballmer added:

The truth is, we get new opportunities. Today when we sell software, say, to an enterprise customer, we hand them a CD, and they go instance it. If we are instead running that server for them, if we’re providing operations support, we see the opportunity not only to monetize the IP that would have been in the software license, but also to derive additional margin from the value add of being able to provide service-level agreements, and guarantees, and support. And see our overall sort of pool of opportunity increasing. We’re the only player in this market who is building the future based on the present. We’re building off of the strong enterprise presence we have, and moving those things to the cloud.

All of that makes a ton of sense. What is questionable is Microsoft’s forays into other markets where it may not have a clue. With Microsoft’s billions of dollars the primary attitude is to shrug off big investments like the Xbox, Live Search and media properties, but a little focus–ideally on the enterprise–could create a lot more value.  Are the thin profit margins on the Xbox–relative to software– really worth the effort?

 

Consider the entertainment and device division:

Vs. the business division:

No matter what Microsoft does, forays into gaming devices won’t be as profitable as enterprise software. Was that a route worth taking? As Ballmer ponders world domination, he may want to dust of the playbook from IBM’s Lou Gerstner and Sam Palmisano. It’s not as glorious as catching Google, but it’s arguably more effective–and certainly more profitable.

Comments

[User 58276]

If that load of cliches, mush mouth, and platitudes uttered by Balmer is an example of how Microsoft intends to compete in the ad business, I couldn't agree with you more. Instance the CD; monetize the IP? What hogwash!

Whatever happened to executives being able to speak English?

[The SimpleAccountant]

User asks "Whatever happened to executives being able to speak English?"

Most (good ones) do, but tech industry executives seem to be more challenged in this area.

The two sets of divisional income statements, however, speak with the unmistakable clarity of the universal language.

[Rokjok777]

MSFT views everything as a potential "platform" play. That means it takes years to assemble all the pieces, but if/when they win, it's huge. In ads, they want to become the one-stop shop for all the needs of an advertiser. Not just ad words, not just display, not just mobile, etc. If you hook that to their enterprise presence (desktop, apps, server, and now enterprise search with FAST), the potential is enormous. GOOG? nowhere to be found in the enterprise. They installed their search appliance at a few enterprises, crawled the network, then "Oops!" if you searched for "executive compensation" it spit out all the execs comp packages. No enterprise permissioning or control. Not ready for prime time. Ad to that the complete lack of support and it's hard to see how GOOG gets anything done in the enterprise in the next decade or so. And what are enterprises? Advertisers, duh. If MSFT can pull off this link, could be very good for them.

[yohoho]

"but you have to wonder about the returns here"

Personally, I love the long-term approach that Ballmer and Co. are taking. Its REFRESHING and I wish more American businesses would/could do it.

If you're curious about the IRR, which is what you are worried about... go re-listen to Chris Liddell's presentation before the closing Q&A. He showed a slide or two that made a TON of sense.

[OldMacHand]

"Instance the CD; monetize the IP? What hogwash!" It's market speak.

Ballmer is a marketing guy, put in charge of a high tech company with a monopoly. That is a deadly combination.

I worked for a company like that, high tech with marketing guys in charge. It had a monopoly on copying and these marketing exec's thought they were very smart because the money just rolled. But they never understood the technology. With all the cash, they bought up lots of high tech start ups, funded world class research labs which enabled them to get into all sorts of side products that never made money. Even though the labs acquired companies gave them a 20 year head start they mismanaged the digital transition because of their ignorance of the technology and lost their monopoly. So from a high flier in the 60's and 70's they almost went under, stock now has gone nowhere in the last 10 years or more.

For another example, think of how the marketing CEO almost ran Apple out of existence.

The monopoly postpones the inevitable but Ballmer is following the script and will do the same to Microsoft.

[David Lentz]

"Ballmer is a marketing guy, put in charge of a high tech company with a monopoly. That is a deadly combination."

This struck me as incredibly insightful, until I remembered that this would also fit Apple just as well (settle down, I'm a Mac fanboy, I can say these things).

Steve Jobs is basically a marketing guy (par excellence), and Apple has a definite tinge of monopoly about it, what with the proprietary nature of its products.

So let me make one small adjustment to the statement:

Ballmer is an incompetent marketing guy, put in charge of a high tech company with a monopoly. That is a deadly combination.

There. I think that fits a bit better.

It will take quite a while for the Company that Bill Built to run through all that cash, especially while their corporate monopoly keeps rolling in the dough, year after year.

But if we look a bit closer, we see a failed internet strategy, a failed video game strategy (look at the cash flow of their games business and call it anything else, if you dare), and a distinct inability for the company in innovate. Yes, they managed to steamroller the competition when the industry was taking its first feeble steps, but once the personal compter business matured, they were unable to squash competitors the way they could when the PC world was new. So there is a weakness that can be exploited.

Looking ahead, I can envision (perhaps more wishing than seeing with clarity) a future in which competitors hollow out Microsoft's non-corporate markets, and make inroads into the corporate markets in small but significant ways.

The stage is then set for some event to cause corporations to defect en masse to alternative platforms (which might not even be PCs, but perhaps cellphones talking to mainframes or cloud resources), gutting the nice annual returns that Microsoft harvests from its captive corporate customer base and tearing a gaping hole in the Redmond Titanic cash machine. THAT will be when the cash gushes out of Microsoft like a ruptured oil tanker.

Until then it's probably a good dividend play, as Ballmer will be forced to pay significant cash dividends to pacify growling shareholders.

[thedonald11]

So David, Does the "good dividend play" then make you a buyer of MSFT ?

[David Lentz]

Actually, no, the potential washing away of their base and the lack of any products that actually appeal to me (remember, I'm a Mac fanboy) offset the likely-to-be steady stream of big dividends. The dividend yield is the ONLY reason I can see for anyone to buy Microsoft.

If I'm looking for growth, AAPL strikes me as a much better buy than MSFT.

I think that Microsoft's growth years, back when they could bulldoze their competitors by any number of tactics, even good execution, are in their distant past, and are extremely unlikely to ever return. Certainly not under the guidance of Steve Ballmer, and probably not even if Bill gates were to return. Some new rising star at Microsoft would have to take the helm, and much of the talent there is jumping ship these days.

Once upon a time, I actually owned a pretty good position in Microsoft (sold it upon the roll-out of Windows 95, as I though the market was saturated and their growth prospects limited -- so I can clearly be grossly wrong, or at least guilty of miserable timing), but during this millennium, their flame has noticeably flickered.

I don't believe that "focus" (as in cutting the non-performing business units) will help them much, but it would ratchet up the stream of net cash pouring into the Redmond money bins. What they need a LOT more than "focus" is "vision" or "imagination"... whatever it takes to create/enter new markets successfully. The last time they successfully entered/created a new market was when they created an apps suit (a.k.a. Office) -- all of the many attempts to recreate that success since then have failed.

If we look at their most recent major campaign, the attempt to take over the games industry, it was based on their acquisition of Bungie to get Halo, and then build a business unit around it, with a proprietary console, the Xbox. They added other titles, some more successful than others, but never managed to push the competition into the sea, despite running the business at a loss for many years, supported by the profits from Office and Windows. Indeed, it might be the case that their competitive threat only spurred Nintendo to greater heights, and produce the Wii. The Wii is an example of a company that looked at their bread-and-butter business, and created something different, walked away from ever-increasing clock speeds, pixel densities, etc, and instead took an entirely different direction, making a product that was solidly profitable (yet much cheaper in cost) than the competition, and basing its appeal on large-scale body movement interfaces. That vision is being reqarded by a significant expension of their marketplace (now many retirement homes or non-gaming adults are buying PS3s or Xboxes?). THAT's vision and creativity!

Consider what might have been if Microsoft merely pushed games software, and not wasted fortunes on their hardware endeavors. The games business unit would have been a profit generator on par with their Windows and Office segments, certainly eclipsing their server-oriented software business unit. Can you imagine the revenue from a Wii version of Halo (even with degraded graphics)? They could have dominated the games software industry.

Some would have us believe that this can still be accomplished, but they have wasted too much time. Bungie has bought their freedom, the Wii is upon the industry, gobbling market share at a ferociouos rate, and Microsoft is slowly being pushed back into the sea themselves on the games front, and even in the home and educational PC markets. There was a time when such a strategy might have worked, but that time is long past. Milking the dividend stream is all that remains for the investing community.

[David Lentz]

Buying failing stocks for the dividend yield would lead one to buying banking stocks or investing in REITs. Not my cuppa tea.