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Excellent letter. Not sure I agree with just paying such a high frictional cost. At a minimum your letter gives excellent food for thought. I am not stating that I don't agree with your reasoning. I just need to ponder your suggestions. Of course your suggestion is more compelling if MSFT were to make future poor capital allocation decisions, and you cited at least one, and possibly two, if you include Skype. As I was reading the annual report this week, I did question the purchase of Skype, only in amount.

The following were some Observations of 10-K for F2012.

1. Skype cost $8.6B. I have been wondering if Microsoft’s capital allocation has been successful.

2. The report is confusing at times. Can’t put my finger on it, but they seem to play with the reader. One example is the ability to read about the $6B goodwill write-down. It seemed to blend into the pages. I could be incorrect, and I was probably just missing it. The conversion of debt and derivatives is also confusing.

3. I am wondering if Microsoft has changed philosophies in reporting and conservative accounting from the old days. I seem to recall the Research and Development was immediately expensed, and that stock options did not exist. This seems not to be the case anymore. R&D is capitalized at end of product cycle development, and Stock Options do exist. Yet, options are not heavily dilutive. Stock options for F2012 were in the $2.5B range.

4. Important to note that Windows Live, which I think is a big part of X-Box (Devices and Gaming), is included in Windows and Windows Live section.

5. Online Services Division (“OSD”) includes Bing. Seems like OSD lost $8B in F2012. This loss included Goodwill impairment charge of $6.2B.

November 15, 2012 (26.77) Thesis

Microsoft has a AAA balance sheet. Close to $8 per share of cash as of 9/30/12. Free Cash Flow and earnings are both of high quality, and I believe both to be stable at a minimum. P/E ratio is 9.39X, based on our projected F2013 earnings of $2.71 per share. Dividend yield is 2.86%. We project the dividend payout ratio to be a healthy and conservative 30%. I don't see them being replaced in enterprise. Trying to "kill this investment," and I can't. I just don't see the degradation of the company that so many others discuss (see yearly comparisons below). My favorite part of the investment thesis is the current price. Of course, could go lower, a lot lower, but that is the way investing is. I think many think that revenues have not been increasing, or are in decline. Maybe the stock price catalyst would be the understanding of the simple math, and seeing that revenues, contrary to popular perception have been on the rise for a decade + (not including F2009 where there was a decline.) Projected investment returns for 15 years are estimated at 15% to 22% annualized based on current price. Waiting to hear penetration of Surface. Windows 8 projected to be slow but steady penetration, similar to Windows 7.

I digressed from my original intent of my post, which was to commend you for such fine work. I think your letter to BOD could go viral, and certainly create food for thought.
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