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Microsoft Corporation - Andy Gets Wet

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December 12, 2010 – Comments (11) | RELATED TICKERS: MSFT , GOOGL

It seems that everywhere we turn these days, the buzz is on about cloud computing. There are commercials that send people "to the cloud", and never ending radio spots that refer to cloud computing.

Get a grip folks! There is nothing special about using the internet to create and access computer files. The ability to do that has been around a pretty good while.

Ever heard of Google Docs? Or how about this? Have you ever accessed an e-mail account via the internet from a computer that was not your own? Welcome to cloud computing.

The point we are trying to make is that it’s all a bunch a hooey, intended to make the consumer, or in this case the investor, think they on the cutting edge of some new and unique technology, when the truth is, they aren’t.

Noted investor Arnold Van Den Berg mentioned cloud computing in his recent newsletter to investors, as did much less noted investor Whitney Tilson in his recent presentation to investors.

But what really made us wonder about cloud computing was not that investment advisors were talking about it, but it seemed to us it was being used to justify putting their client’s money in Microsoft Corporation (Nasdaq: MSFT).

Certainly we think Microsoft is a great company. We simply believe, cloud or no cloud, the company’s stock is currently trading at fair value.

Basis

Financial information for Microsoft Corporation is based on the company’s most recent SEC Form 10-K filing, for year ending June 30, 2010, as filed with the Securities and Exchange Commission on July 30, 2010.

What They Do

The company develops and markets software, services, hardware, and solutions that they believe deliver new opportunities, greater convenience, and enhanced value to people’s lives, doing business around the world with offices in more than 100 countries.

Revenue is generated through the development, manufacture, licensing, and support, of a wide range of software products and services for many different types of computing devices.

The company’s software products and services include operating systems for personal computers, servers, and intelligent devices; server applications for distributed computing environments; information worker productivity applications; business solutions applications; high-performance computing applications; software development tools; and video games.

In addition, the company provides consulting and product and solution support services, as well as trains and certifies computer system integrators and developers.

And Here It Is

Normally we would not include the following, but having read the tomes of several investment advisors that think cloud computing is the greatest thing since sliced bread, we just couldn’t resist this little ditty from the Microsoft 10-K.

We earn revenues from customers paying a fee to license software; that will continue to be an important part of our business, even as we develop and deliver “cloud-based” computing services. Cloud-based computing involves providing software, services and content over the Internet by way of shared computing resources located in centralized data centers. Consumers and business customers access these resources from a variety of devices. Revenues are earned primarily from usage fees and advertising.

Short-Term Investment

The stock had a recent close of $27.16 with Resistance at $31.58 a 16% increase from a recent close and Support at $26.59, a 2% decline from a recent close.

The current stock trend appears to be upward, recently peaking in overbought territory, and it appears at least to our untrained eye, that the stock should continue to move upward over the near term.

Long-Term (5 Year Hold) Investment

The company certainly has impressive financials, with a Current Ratio of 2.13, an Acid Test Ratio of 1.9, and a Cash Ratio of 1.41, there is little to dislike.

Couple these ratios with a negative Cash Conversion Cycle, Return On Invested Capital of 34%, and Free Cash Flow of $1.86 per share, and an inventory turnover of 13 times a year, and it’s easy to see why investment managers are keen on sticking their client’s money in the stock.

Valuations

Based on our review of the company’s latest annual financial statements, we think the company currently has a Reasonable Value of $36, and have set a Buy Target at $22, a First Sell Target at $42, and a Close Target at $45.

The company has an Enterprise Value of $27, an Equity Value of $27, and for FY10 earned $2.25 per share.

Given the stock’s recent close and the company’s FY10 earnings, provides an Earnings Yield of 8.23%, a yield about 4 times greater than the recent 2.01% 5 Year AAA Corporate Bond Yield.

Final Thoughts

As we mentioned earlier, cloud computing is really nothing new. What does seem to be new is that today, someone has provided a name for this method of accessing computer files remotely.

While the buzz surrounding this method of computer file accessibility will no doubt be perpetuated by almost everyone with something to gain by its use, we simply don’t believe that is going to add any great increase to the current value of Microsoft.

In fact, sorting through all the spaghetti that has become cloud computing, we believe the company with the most to gain from the use of cloud computing is Google, Inc. (Nasdaq: GOOG), via their already in place Google Docs applications.

Accordingly we think new investors in Microsoft are going to be sitting underneath a bit of a dark cloud for the foreseeable future. We just hope they have their umbrellas handy.

Wax

11 Comments – Post Your Own

#1) On December 12, 2010 at 8:34 PM, portefeuille (99.60) wrote:

we believe the company with the most to gain from the use of cloud computing is Google, Inc. (Nasdaq: GOOG), via their already in place Google Docs applications

The "google docs part" is a negligible part of the "value" of GOOG. And that is highly unlikely to change.

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#2) On December 13, 2010 at 6:45 AM, dbjella (< 20) wrote:

Do you think MSFT will raise its dividends to raise the stock price?

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#3) On December 13, 2010 at 8:19 AM, wax (96.58) wrote:

dbjella;

We do not.

The company repurchased slightly more than $11 billion of common stock during FY10, ending the year with more than 8.5 billion shares outstanding. Yet the share price never rose higher than about $30.

What drives share prices higher is earnings.But with 8.9 billion shares outstanding, we think the company is going to be hard pressed to show much of an appreciable increase in per share earnings.

Even if the company were to increase it's dividend to $1 per share, we don't see that there would be a noticeable change to their financial statements.

Wax

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#4) On December 13, 2010 at 8:24 AM, wax (96.58) wrote:

portefeuille:

Well the point was not that it would increase the value of Google, althought considering from a marketing perspective what Google could do with Google Docs it could contribute mightily to earnings, but rather to show that contrary to what is being said, Microsoft once again is late to the party when it comes to remote application access.

We would not at all be surprised to see Microsoft attempt to create some sort of international standard for remote computing, which if memory serves, is how the company originally caught up with the rest of the computing world when it came to the internet.

Wax

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#5) On December 13, 2010 at 5:36 PM, miteycasey (31.29) wrote:

Microsoft is a marketing company first and IT company second.

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#6) On December 14, 2010 at 11:20 AM, Goofyhoofy (< 20) wrote:

**What drives share prices higher is earnings.But with 8.9 billion shares outstanding, we think the company is going to be hard pressed to show much of an appreciable increase in per share earnings.**

Earnings per share [from ValueLine]: MSFT

2000: $0.85 

2001: $0.90

2002: $0.94

2003: $0.97

2004: $1.04

2005: $1.16

2006: $1.20

2007: $1.42

2008: $1.87

2009: $1.62

2010: $2.10

2011: $2.45 (est) 

They got hammered in 2009 as companies held back and delayed upgrading because of the financial crisis, but otherwise they have done very nicely improving eps. 2009 is a clear anomaly, and they brought the curve right back to where it would have been anyway in 2010.

Microsoft is one of those rare creatures where earnings have continued to improve but the stock has flatlined. If earnings continue (always a big if) you can expect some reversion and a quick run-up in price to get back to 'normal'. I expect earnings to continue for a while, at least, given the success of Windows7 (big replacement cycle after Vista), the Xbox Kinect feature, and the potential sales of Windows loaded phones (although that one is more iffy, in my view.) The Office franchise seems unimpeded even with newly energized competition from Apple and Android, and often runs an upgrade cycle a year or two behind a new OS upgrade.

Microsoft; share price plotted against earnings:

http://invest.kleinnet.com/bmw1/stats20/MSFT.html

WalMart is another

http://invest.kleinnet.com/bmw1/stats20/WMT.html 

This has happened before to WalMart, they flatlined for several years in the 90's, then went on a tear and jumped up quickly. Here's why: http://boards.fool.com/right-but-why-did-it-get-to-such-super-high-28938741.aspx 

Reversion. It happens. 

[I have a position in WMT, none in MSFT. In fact, I don't even like them much, but numbers is numbers.] 

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