Bill May Return to Microsoft, or Not.

With all the hot news stories--like the budget deal and the Middle East--cooling into sludge, it's the moment for the New York Times to opine about the "widespread fascination" about the future role of Microsoft Chairman Bill Gates.  The story tries desperately to titillate the reader about Mr. Gates' increased presence at product introduction meetings.

On the other end of the spectrum, I have to applaud two institutional shareholders who, according to the New York Times, approached the company to have it consider having Mr. Gates relinquish his Chairman's position because it would inhibit a new CEO from adopting radical changes from the existing strategies that have cemented the company's role as a tech follower, and a mediocre one at that.

I don't believe that either of the above two events will come to pass.  Mr. Gates is having too much fun with his philanthropic projects in education and global health to return to the drudgery of extracting this company from the mud and getting its culture jump-started again.  As a co-founder and large owner, he wouldn't countenance losing face by relinquishing the Chairman's role without some future bridge-building to a CEO whom he respects and who has produced some results.  Too early for this.

The CEO of Ford makes the current short list of successors to Steve Ballmer.  Sell the stock on the announcement of Mulally's appointment as Microsoft CEO.  Watch the exodus begin on the servers and tools sides of the business.  Damage control all around, because it makes no sense.  Nothing else looks new, except that people like former Motorola Mobility CEO Sanjay Jha don't appear on today's list.

On the Microsoft Surface side, it's interesting to hear some different views about the Surface RT.  About a year ago, writing about the launch, we made a couple of key points:

1. "The question now becomes, can they act like a consumer products company and tell their story to the customer?
2. "The cost of making every buyer happy is a better investment that buying back shares.  That cost is just another form of advertising and brand rehabilitation."  Can they commit to making buyers happy?

Unfortunately, the answer to both these questions has been "No."  We know that the company took a write-down, forget that.  Some British IT users call Microsoft's marketing of the Surface RT "absolutely shocking," which in American English would translate into a profane phrase.  Why?

We've written before that most people still use their iPads as photo albums, video cameras, and places to find maps or restaurant reviews.  They are not productivity tools, and far from it.  The British buyers don't care about the shortage of "rubbish apps that you download and never use again."  Rather, they do like being able to use Office for document work and to connect easily to printers.  This indeed is productivity.  So Microsoft produced something better, but they didn't communicate to users what they had produced and why it was better.  

Now, they're going to cut prices and release Windows 8.1. Okay, but what about those people who took the risk first and got hosed?  Bill Gates should send everyone of them a computerized, hand written note saying, "You took a bet on us, and we let you down.  We've learned and I promise you that it won't be at your expense.  Come to a Microsoft Store, let us swap you out to a new machine, transfer your data to Sky Drive, and we'll give you a coupon for the price difference that you can use at the app store. Bill"  Let the accountants get busy. No one will care, except for consumers who would be shocked by a show of customer care, strength and confidence. It won't happen, but it should. 

Warren Buffett Follows Up With Michael Dell

Dear Michael,
I wanted to follow up on my last letter about your cramming down the SilverDell deal on your shareholders.
Listen, I know that you're very busy, and now that you're in bed with the private equity types you will truly see what "hell on earth" really means.  You'll long for the days with your fawning analysts and compliant public shareholders. Good luck with that project.

I wanted to follow up on the Goldman deal that I made, as I'm sure that you don't keep up with our picayune business.  To reiterate, I threw Goldman an expensive life line during the crisis, and this was to people who really understand what "expensive" means.  If I've learned one thing, it's that markets retrace from overshooting both ways.  You just have to be there with dry powder, make your deal and be patient.

Anyway, not to lecture.  Berkshire invested its $5 billion into the preferred shares and picked up $1.5 billion in dividends before Goldman redeemed the paper, paying us an additional $500 million.  Since the stock was about $160, well above the warrant strike price of $115, they came to Berkshire to offer us a deal for fewer shares without splashing out the cash.  The accounting treatment will be sweet, and the tax treatment even better, not to mention all the cash that's already rolled in.

Berkshire now owns 3% of the premier global investment bank, and I know that if they ever get their shorts in a knot again, the Feds will bail us all out again.  For all my railing about executive pay and CEOs paying more taxes, Lloyd Blankfein ,who like you knows how to pay himself well, works for me!  How sweet this capitalism is.  My shareholders love Charlie and I, while Llloyd's love him, and it's a love fest with Wall Street.

Which gets me back to Dell. Are your assets, namely your people, walking out the door as all the bureaucratic machines grind through getting your deal approved?  Was this mess really the best thing for your company? If you ever come back to the market to sell a public deal, wait three to five years so they won't remember who you are.  Wall Street is fickle and forgetful.

Unfortunately, I don't see Berkshire being interested in anything you're doing.  It's a pity.  But, you see I a make 8,000 meter mountains of money investing in things like banks, railroads, insurance, machine tool makers, candy and ketchup makers.  It's not as highfalutin as your tech world, but more profitable and more fun!

I'll look for you in the pages of Barron's, Michael.

My best,

Warren Buffett

Checking In With Tech's Four Horsemen: Microsoft

As the whole CEO succession debacle continues to unfold at Microsoft, I continue to be amazed at their inability to deal with longstanding, loyal, zero resource demanding customers like myself in a way that makes me feel good about our relationship.

I somehow got signed on for a trial subscription to Office 365.  I want to cancel and to find out how this subscription was initiated.  Emails, after a lengthy delay, generated a support incident link; clicking on the link in my Chrome browser generated nothing by a little X in the center of the white screen.  Lots of attempts to figure out how to change Chrome's settings to display the Microsoft page failed.  "Aha," I said to myself, "of course, the geniuses at Redmond want to thumb their noses at Google and at me to make me use Explorer as my browser."

Reluctantly, I open the resource hogging, hacker inviting, slow as molasses IE, and it too cannot display the message from Microsoft support!  More emails to Microsoft, using the address header eventually send instructions about going to "Internet Options," and authorizing Microsoft support twice as a trusted site, one on the support site, and a separate authorization for the secured support page.  Ridiculous, right?  This is their own browser and their own communication!  After doing this a few time, Explorer still can't display whatever it is Microsoft is trying to tell me.

A couple of times, the site displays, flashes suddenly and then displays an error about frames not being able to be displayed.  All of this because I want to cancel a subscription that I didn't intentionally order, if I ordered it at all.  The last thing in the world I want to be doing is to be figuring out browser settings on my time.

After no communication to resolve my issue.  I actually got a customer satisfaction survey about their support, without ever having resolved anything.  It is the first time in my life I ever filled out a survey with every answer being the most unsatisfactory level possible.  "How would you like to hear from us?"  Smoke signals would suffice.  A post card?  Weeks have gone by and nothing from the company that Steve Ballmer has led into the brave new world of technology.

It is going to be a great supplier of technology hardware, software and entertainment to the masses.  I don't think so because they have no idea what this involves.

JP Morgan New Narrative: Shareholders Are Victims!

We are a nation of self-anointed victims. Victimhood extends both across our population demographic and up and down our economic demographic to include institutional shareholders of JP Morgan Chase, according to the New York Times and to Professor John Coffee of the Columbia Law School.  He should know better, but here's a quote:

“It is perversely inappropriate. You are adding injury to injury. All we’re doing is punishing the shareholders more,” said John C. Coffee Jr., a professor of securities law at Columbia Law School. “This is a case where the victims are the shareholders.”

These remarks were made as JPM paid $920 million to "settle" civil cases related to the London Whale fiasco.  This is just the beginning, as politically ambitious politicians, Federal prosecutors, and corporate governance activists jump on the bandwagon to feed at the trough filled with the shareholders' assets.

It's the fault of the shareholders, and they deserve nothing but what they get, which may not be too much of a penalty on the stock prices, since QE infinitum continues to expand forward multiples.  These same shareholders bought into the findings of the London Whale report without demanding any changes in the way this sprawling financial supermarket is managed.  They also chose not to split the Chairman and CEO roles, in a referendum on Jamie Dimon's popularity.  They also backed not penalizing or changing the structure of management compensation.  These folks are not victims but lazy and uninvolved in delving into their own investments beyond the newspaper and analyst reports, which might as well be newspaper reports.

Shareholders should not be rescued from their own lassitude.  They always had the opportunity to sell, and they must be copacetic with the management of their company.    Shareholders, in turn, don't refund any of their investment management fees for separate accounts or overpriced mutual funds due to their lack of diligence, so let's leave this narrative where it belongs, in the circular file.

Microsoft Analyst Day: The Good, Bad and the Ugly

The good, bad and the ugly were all on display at Microsoft's 2013 Financial Analyst Day.  I didn't have the stomach for the whole shebang, but looked through COO Kevin Turner's slides and listened to part of the Questions and Answer session before succumbing to reading the transcript.

The good stuff is not new, and it all appears in Kevin Turner's slides. The issues for concern are in the behavior, body language and interactions among the COO, CFO and CEO that are evident in the video of the question and answers.

I was surprised by the amateurish character of  the whole setup for a global technology industry leader. How can they help their customer companies do better when they can't even run an important corporate presentation for themselves?  Despite all the remote mikes, a webcast viewer can never hear the questions from the audience.  The transcripts reflect gaps by saying "Off mike," when they can't pick up the speaker. How 1980's!  The lighting is out of balance, poorly placed and gets so bad at one point both the CFO and CEO put their hands over their eyes to look out into the audience.

For a small cap company, this is trivial; for Microsoft at an equity market capitalization of $273 billion, this is just inexcusable and, worse, inconsistent with their image and messaging.  Indicative, but small.

Here is the first question in the Q+A:

"QUESTION:  (Off mike.)  Just a real quick question for Amy, the $6-1/2 billion of CAPEX that you have for Fiscal '14, obviously a big step up from previous years, is that a one-time step up and then back down, or is that a sustainable level for the next several years?

AMY HOOD:  Well, what I would say is that if you're in the devices and services business and you're successful, I would hope that we continue to need to invest capital to build out the infrastructure and the server capacity over time.  So that's how I would think about it."

Simple question.  In fact, to open a session, it's clearly a softball, pitched for the CFO to hit it out of the park. This is the role of the first questioner who wants to do the company a favor.  The answer is not only non-responsive, it makes no sense.  The first thing to do is to reject the "one time" argument as this would make no sense either.  After that, some general comment about a range for the representative level of capital expenditures in the coming years, without making a forecast, would suffice.  Or, to work off the COO's slides, "Look we're pursuing a $181 billion market opportunity in cloud computing, and you see how fast we're already booking business from Kevin's slides, so we'll commit to higher levels because we already see the returns from that business."  

We have expressed concerns about the incumbents in the CFO chair before, and based on what we see and here in this exchange, it is still a real issue for shareholders.  The CFO has to be a strong personality, and shareholders look to that chair as a counterweight to overly optimistic, aggressive CEOs who are expected to be over the top.  The CFO has to make sure that the shareholders' money and interests are well protected.  Here's the flip side of the problem from an extremely loud and overcaffeinated Steve Ballmer. 

"STEVE BALLMER:  I don't know what really happens in all the telecom companies, but at least the myth of the telecom companies from 20 years ago, we should make the investment, huge CAPEX, and then it all goes away, success as Amy said breeds new CAPEX here.  There's no sort of point of saturation if our customers continue to buy more stuff from us.  We would consider that a first rate problem."

Talk about making no sense! Who cares about telecoms from 20 years ago?  Did Amy say "success breeds new capex?"  Capex of $6 billion is not any kind of "problem" for a company with no net debt and $75 billion in cash: that wasn't the question.  It was a softball question for an analyst modeling free cash flows for the next few years.  Mr. Ballmer stepped in with both feet because he didn't like his CFO's answer, but the trouble is, he made it worse not better.  Watch the CFO cringing as he speaks.  

Having a weak role and a revolving door of undistinguished players as CFO will be an issue for the company going forward. 

A critical question was asked in a very soft way by another analyst, and the way it was treated demonstrates the basis for our concerns expressed in a previous post.  

"QUESTION:  (Off mike.)  There is the perception that you need different types of skill sets to operate both in enterprise and the consumer business.  I guess as you see this leadership transition coming in, I guess do you feel that internally you have the skill sets to manage both a very large enterprise company as well as a very large consumer company, and does ‑‑ I guess how does that impact your view or the board's view of who makes sense to take over for you?  Thanks.

STEVE BALLMER:  I mean this is one people like to jawbone about, and I don't quite get it. We've been selling to consumers and enterprises basically since about 1985.  It used to be people thought we were better at the consumer side and worse at the enterprise side.  Now people think we're better at the enterprise side and worse on the consumer side.  I'd love everybody to say you're good at both sides, but I don't see the fundamental disconnect.  I really honestly don't feel it even in the culture of the place."

This is a problem, and will be a problem for the new CEO as (s)he struggles with the Microsoft Leviathan. Mr. Ballmer's history and biases dominating a weak board along with Mr. Gates will stand in the way of Lew Gerstner-style actions from a strong CEO.  Here's a different way of looking at the past.

Microsoft was only "better on the consumer side" because of the OS monopoly created by the WinTel axis and by the domination of the PC in the corporate workplace.  Monopolists make profits not because they're smarter, but because they don't have to compete. 

When Microsoft competed as a monopolist, their culture was not to beat any competition, but to nuke them out of existence.  They were able to do this by dint of their lockup with Intel and by the huge cash flows from the boxed software licensing business. 

Remember when Microsoft wanted to buy Quicken, the best consumer money management software by a mile?  When the regulators stopped this, what did Microsoft produce?  Micrsoft Money!  This was a terrible product even for Microsoft, and I speak as a user who abandoned ship early.  When Personal Information Managers (PIMs) first came out, there were a number of innovative products first-to-market, but somehow they all disappeared and Outlook eventually took over.  Remember Netscape?  Now we have the bloated, resource-hogging Explorer xx.  I use Chrome, which runs fast, smoothly and almost never crashes. But, Microsoft Web Apps don't play well in Chrome, so a user is often forced to go back to Explorer.  

The point is that I, as a Microsoft consumer user from the earliest days can honestly say I never have regarded them as being good at anything, but there was never a seamless alternative.  The switching of the consumer software model to Office 365 really doesn't make a lot of sense unless a home has five PCs which is probably a 1% group.  That model for consumers is not attractive.  How Microsoft does as a consumer company going forward  cannot be predicted from the past; if it were extrapolated from the past, the future would be grim indeed.  

What are some of the points from Kevin Turner's presentation?  A balanced revenue portfolio.  Good, but let the company focus, and let investors diversify their portfolios themselves.  We've talked extensively about capital allocation.  The Enterprise businesses are attractive and Microsoft may ultimately be a stronger competitor than Oracle and other established players on the software and services sides, but that is still an open question.

One of the most interesting slides from Kevin Turner's presentation is one depicting revenue from three large scale corporate customers, pre and post-cloud computing services.  It shows Office 365 and Azure customers, and the year-over-year revenue gains are on the order of 20% or better.  Again, the problem is that the sales efforts and compensation models for these businesses are quite different from the consumer businesses.  Let the Microsoft Enterprise stand alone and do its thing while creating value unencumbered by the legacy of a consumer-unfriendly culture endemic to Microsoft.  

I know that these Microsoft posts are very widely read around the world from the stats, but send me some comments because I want to know about other ideas too. 

Microsoft's 22% Dividend Hike: What's The Signal?

So Microsoft raised its dividend 22% ahead of its Analysts Day.  This compares to a widely expected level of 15%.  It also announced a $40 billion share buyback authorization. From John Lintner's 1956 publication, the notion of dividends as signals to the investor marketplace is widely spouted, but not well understood.

So, in the case of Microsoft what could the dividend and the buyback be signaling?  Here is a succinct summary of the signaling case from a 2011 paper by Baker and Wurgler of Harvard Business School and Stern School, respectively,

"Standard dividend signaling theories posit that executives use dividends to destroy some firm value and thereby signal that plenty of value remains. The money burning takes the form of tax-inefficient distributions, foregone profitable investment, or costly external finance."

The research from investment analysts and management consultants on whether share buybacks add or destroy value has generally been negative.  According to a Credit Suisse report by Zion, Varshney, and Burnap from June 2012, the information technology sector bought back $619 billion of stock from 2004-2011, accounting for about 23% of all buybacks from the ten Standard and Poors industry sectors; information technology was number one by a wide margin.  So, in a sense, buybacks come with the territory of being a technology leader.

The Credit Suisse analysts, when they use a benchmark cost of equity against which to evaluate the economic value-added from a buyback, note that only 36 percent of the Standard and Poors companies which bought back $2.7 trillion of their shares during 2044-2011 added value by doing so.  So, 64 percent of our leading public companies destroyed value by their share buybacks.

What's more out of the Top 10 companies that spend more than $1 billion in share buybacks and earned the highest annualized returns above their costs of equity, none of them were in the information technology sector. Rather they were in prosaic industries like tobacco, retailing, and distribution. One financial services firm and a medical device company were in the group.  So, tech companies don't seem to play this game well, according to the most recent period surveyed.

(A 2012 paper by Lambrecht and Myers of the University of Lancaster and MIT Sloan, respectively gives another, more provocative theory about share buybacks.  For those readers who like academic research.)

Microsoft is being set up by the press as facing a tough Analysts Day.  Compared to the HP Investor Day, this one looks extremely bland, more like an extended conference call. Investors have seen their company destroy value through repeated, fundamental misreadings of the evolution of personal and business technology, together with acquisitions that seem to trail innovation rather than blaze the path.

Investors are not worried about the level of dividends or share buybacks.  They want to know if their company will continue to be a leader in the new technology bazaar, not the old Technology Officers Club. Some of the key questions are corporate organization, executive management, the portfolio, allocation of capital, the innovation process, management incentives, and the CEO succession.  Unfortunately, all of these are effectively off the table due to the timing of announcements, by fiat in the case of CEO succession, and by the fact that there are no answers now.

$1.5 billion in Office 365 revenue is pointed to as indicating great things.  I have my doubts, but the truth is that the rationale for consumers and business adopting this model has not seemed convincing.  I recognize that there is some rationale for big corporate licensees, but that's assuming that they don't eventually get fed up and go to a better option being developed elsewhere.

Arrogance and the power of the monopolist is what built the company's cash horde.  The Windows model is winding down, perhaps slowly but inevitably. Trying to become a consumer oriented company around hardware goes against the company's evolutionary DNA.  Consumers are price-driven, fickle, demanding and always set to move to the next big thing.  Microsoft is unlikely to become a leading gaming or entertainment company under its current structure.  How are these issues going to be resolved?

This is where the value will be added, not by short-term share buybacks and dividend hikes.  Microsoft's board charter should to make sure that the company stays in business forever, to paraphrase Harvey Mackay.  Given its current financial strength and many assets, investors need to understand how the past egregious destruction of value will give way to a new era of value creation.  That is the beginning and the end of the story.

Let's see if we know anything more after the Analysts Day.

Microsoft's CEO Transition: A Play in Two Acts?

In the past few years, one of the biggest topics put forward by corporate governance gurus has been the importance of boards working on CEO succession.  This would include, of course, the development of potential internal candidates.

In the case of Microsoft, given Ballmer's thirteen years of leading Microsoft wandering in the desert, a board which was not asleep should have developed some concrete plans for succession. So, now this board is going to choose the single individual who can lead Microsoft beyond its bloated and dysfunctional culture to become a new tech industry leader?  Highly unlikely, and even more unlikely that such an individual exists.

Let's dismiss a couple of absurd suggestions.  The Messiah Returns: Bill Gates should come back as CEO.   Second acts for leaders of the same enterprise rarely work.  Steve Jobs, yes, seems to be an exception, but the Apple he left was not exactly the Apple he came back to, so he had to refocus the company's product development efforts, not gut the company first. Bill Gates would have to gut the company which has become bloated and dysfunctional under his hand-picked successor, all the while he was assenting to the foolish moves as a board member.  No, this is totally absurd and ridiculous, plus he's more interested in TED talks and philanthropy.

The Energetic Tech Leader: lots of names circulated in the press, including mad ideas like the CEO of LinkedIn. The problem is that Microsoft had a strong player of this ilk when Ray Ozzie was Chief Software Architect. He couldn't accomplish much in a brief spell.  Younger, internal candidates, I believe, would find the sprawling Microsoft empire difficult to get a handle on, no matter energetic they were.

Another peculiar feature of Microsoft---quick, name the past two or three CFOs of Microsoft. The CFO in this company seems more like a Treasurer or Chief Investment Officer of a bank than the strategic and operating partner of the CEO.  I've scratched my head over the past four of five incumbents trying to think of an area where they seemed to add value beyond signing the financial statements.  An incoming CEO would not have the advantage of getting briefed by a strong incumbent. A smart, new CEO would need to come in with a very strong partner from outside and upgrade the profile of the CFO if the company's capital allocation were ever to get better, which it probably won't under the current corporate structure.

I think that this drama is best viewed as a play in two acts.  Act One: costs have to be cut, fast and ruthlessly. The deadwood has to removed from the key bottlenecks. Stephen Elop seems to be the person for this job,  having done this recently at Nokia, and he is a former Microsoft executive.  When this tough job is done, and the portfolio is properly pruned and positioned, Act II would begin.  Assuming, in the meantime that the board were completely turned over, the separation of the company into distinct businesses would begin and then three or four new CEOs would emerge for the new businesses, as we have discussed before.

If Elop were able to achieve this agenda as a CEO, that alone would be a magnificent achievement.  Act II would be the beginning of not just an earnings rebound, but a story of real value creation. Then, Elop could move on or get kicked upstairs. Then, a totally different kind of CEO should be chosen by a new board for a Microsoft on a different journey.  Picking one person now and assuming that (s)he would get it all done alone, with this board and this corporate structure, is truly waiting for Godot.