Microsoft Should Keep Searching

We've been reflecting on Microsoft since 2009, a company which often seems like a statistical value, but which often disappoints. Divesting its Bing search engine effort would be the worst thing Microsoft could do, both strategically and from the point of view of transforming investor perception of the company. Hedge fund managers and industry analysts are rightly frustrated with the deployment of the company's assets and its habit of always playing catch-up to innovators like Google.

Any buyer of Bing would not pay full value for the franchise, and to sell it to Facebook would be doubly foolish. Microsoft is an investor in Facebook, and it now has an alliance with the perceived leader in social media. Facebook sees itself as allied with one of the founders of the tech revolution, and it probably sees a good cultural fit with the "new Microsoft" groups like Bing. Why throw this away for a piddling amount of cash, which Microsoft doesn't need?

Even Google, the imposing Transformer, has stumbled a few times. Google Health shut down with little fanfare or recrimination. The government says that EMR's are the key to taking costs out of health care (they're wrong), and Google couldn't come up with a consumer friendly option. Google + (what a lousy name!) is playing catch up to Facebook--not an enviable position.

So, for Microsoft, it's time to put the past behind, and like smart shareholders, look at the future. As Credit Suisse's Phillip Winslow put it, Microsoft's Q4 featured "monster bookings" of unearned revenue amounting to $17.1 billion! Revenue growth was strong in Servers and Tools (+11.9%), Business (+7.5%), and Entertainment and Devices (+28.8%).

So, let's look at Online Services, which includes Bing. Winslow writes that the June quarter had an operating loss of $728 million, or almost $3 billion at an annualized run rate. Online advertising revenue of growth of 19% was less than Credit Suisse's estimate, and revenue per search was down. Think about two years ago, when Microsoft has a 7.2% share in U.S. search, which it has now doubled to 14.4%, and including its powering of Yahoo! search, it has a 27% share of the U.S. search market. This is nothing to sneeze at!

I don't know how Microsoft allocates costs and charges among its divisions, but the operating losses to Online Services probably includes expenses of building massive data centers that power Azure, which is one of Microsoft's cloud computing offerings which will be critical for expanding Service and Tools and the Business Divisions. So, it seems unlikely that the $3 billion annualized run rate of losses in Online Services is the search engine effort itself.

A minor point, but not to me, is that I actually like Bing as a search engine. I was one of the early guinea pigs for MSN Network, taking an MSN email before they acquired Hotmail. I know how lame and poorly conceived their products can be. Bing is very, very different in look, feel and performance: it's a more than acceptable substitute, with certain advantages, like its response to travel inquiries. Remember that Peter Lynch once, perhaps apocryphally, bought Dunkin' Donuts for Fidelity Magellan because he liked the coffee!

The New York Times Sunday article on Bing gives me the feeling that Microsoft has created a different sub-culture in the Bing strategic business unit. Qi Lu, the President of Online Services, is quoted saying his mission is to "change the game," while recognizing that it will be "a long-term journey." Dr. Lu also characterizes most Microsoft project leaders as having a "renters mentality," whereas winning in search means having a "homeowners mentality," which I take to mean being emotionally invested in their business, liking their neighborhood and meaning to stay for a long time. Indeed, the Times reports that's the promise that CEO Steve Ballmer made to the group as he assembled them. I also like the comment because it came not from the usual cliche spouting, Stanford MBA type but from a Carnegie Mellon computer science PhD. I think Dr. Lu believes what he says.

Which reminds me, what about China? This is the place where every business needs to be to succeed, goes the market patter. Well, in its haste to "do no evil" while also taking over the world, Google appears to be have burned some bridges in China. Microsoft's research lab in Beijing produced a key Bing team leader in Dr. Harry Shum, and it appears that Microsoft has wide-open options in overseas markets, including China and others. Microsoft's "Mango" Windows Phone 7.5 supports 17 new languages, according to Tim Carmody. Windows Mobile was less than stellar, so let's hope that they've invested in getting Mango right.

As industry analysts write, the mobile computing/telephone platforms will be the convergent battleground for really expanding and personalizing online advertising and target marketing. We're very likely to have a duopoly in this market, and were Microsoft to exit Bing, the second player would NOT be Microsoft, and this would be a tremendous loss for its shareholders.

Microsoft has integrated Bing into platforms like Xbox Live, which once seemed moribund but which is increasingly popular among twenty-something gamers. All of this multi-platform embedding of Bing takes investment, and now is not the time to take the ill-advised strategy of writing off the efforts. Microsoft, would among other things, break faith with some of its powerful new innovators inside the company, thereby dooming it to be regarded as a dinosaur in the tech world.

Microsoft should look at this issue like Warren Buffett looks at Berskhire's portfolio. Buffett's job is to reallocate cash flows from businesses which don't need them (like See's Candies) to businesses with significant moats and potential for high returns. For once, this appears to be what Microsoft has begun to do with search, in effect diverting large free cash flows from Office to ventures like Bing. Keep it up, Microsoft: don't blink here, and don't be waylaid by short-term concerns.