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David Einhorn Speech On Microsoft

Posted on | June 9, 2011 | Comments Off

This is a very good insight from Hedge Fund manager and owner of Microsoft shares, David Einhorn.  Here are some quality excerpts:

On the positives of Microsoft’s business:

So let’s see what’s happened to that recommendation. First, from an operating perspective, Microsoft has made clear progress. Revenues, profits and earnings have all grown at a decent rate. Microsoft has also repurchased enough stock to make a noticeable impact on the share count. Earnings per share have more than doubled.

Looking at it by segment, four of the segments have shown growth and improvement, the servers and tools growing the fastest. Windows 7 is the fastest selling operating system in the company’s history, with 350M licenses sold and still has the opportunity with a large portion of the installed PC base yet to upgrade. Office products are now used by about 1B people. Newer offerings like Dynamics and SharePoint have consistently grown at double-digit rates, and Window’s share in the server market has also grown from 65-70%, according to Gartner.

Entertainment and devices driven by X-Box and X-Box live has turned from an operating loss to over $1B in operating profits. On the other hand, online services segment has grown mostly in the size of its losses as Microsoft has increased spending on search in an expensive effort to belatedly take on Google.

On how cheap Microsoft is:

Even as the business is out performing average S&P 500 companies by a wide margin, the advancement has been barely above average. While the S&P multiple has gone from 16 to 15, Microsoft’s multiple, net of cash, has contracted from 16 to 7. The question at hand is why. Certainly Microsoft isn’t getting credit for some of its achievements and prospects.

On Microsoft’s misallocation of capital:

Every year Microsoft invests $9B in shareholder money and R&D. Much of it is wasted on product that will never see the daylight, or worse, is spent on products like the Kin, which was pulled from the market after just 48 days.

But a good chunk of that goes to developing future generations of Windows and Office. Perhaps if Ballmer eased up on brainwashing and let his kids play with the most popular devices, he would see the opportunity in making available a version of Office for the iPad and the Android devices.

The search business is another sinkhole. On pace to generate $2.5B or more in operating losses this fiscal year, the sixth year of operating losses. Even for Microsoft, these losses at 25% per share, matter, especially when the losses are growing over time. (I’m going to use Bill Ackman’s 2.5 minutes.)

On how Microsoft should partner with facebook:

Since search is a scale business, and scale comes from traffic, currently Microsoft spends heavily to drive users to Bing. Facebook could help Bing achieve scale and reduce Microsoft’s need to pay for traffic.

Likewise, paid search at scale is one of the most proven high margin businesses on the internet. Microsoft could help Facebook with one of the biggest challenges, namely monetizing its traffic without reducing the user’s experience. It’s obvious that Microsoft needs traffic and Facebook needs search. As the cost to create a new search engine of its own is prohibitive, the revenues paid search through Bing would be capitalized in a much higher multiple on Facebook’s income statement than on Microsoft’s.

With the JV, or perhaps even an outright sale, Microsoft can contribute Bing in exchange for a sizeable minority interest in Facebook. This would be a win-win for both companies and their customers.

Einhorn concludes that CEO Ballmer has to go.  I’m starting to agree with Einhorn on this issue.   The Skype/Nokia move combined with Windows 8 is Ballmer’s last shot at remaining at the helm.  If these aren’t huge successes, I think he’s gone.  Time will tell.

Thankfully the stock can be had for cheap right now.

You can read the entire speech here.