A Very Targeted Tax Cut

Unexplored Territory 

We are in new territory with PC sales in freefall after a new release of Windows and, as some analysts contend, because of Windows 8. Even the Windows Vista “Vistaster” didn’t see PC sales to implode.

Discussions of Microsoft are moving beyond product recriminations to the more fundamental. The time-honored strategy of tying new businesses to the Windows mast is not working, and now the SS Windows is taking on water (if you need some frustration in your life, try Windows 8 on a old-school PC – the tablet-first approach dramatically undermines the traditional keyboard and mouse experience).

Both Goldman Sachs and Nomura’s Rick Sherlund have downgraded the stock today (Goldman to an outright Sell, Nomura to Neutral) and get into more existential questions about the company.

I have argued that Microsoft would be well served to voluntarily break itself up. It would unlock value, deliver a material strategy tax cut to individual businesses and solve the succession question.

Goldman views a breakup as ultimately unlikely but still makes it the first of four “Plan B” strategic options they present (the others are leverage offshore cash/increase debt, massive subsidies for mobile hardware to get into the game or significantly cut costs):

Are the parts worth more than the whole? Our sum of the parts analysis suggests a valuation at the midpoint of about $37.

Their sum of the parts analysis is interesting:

image

Note that Server & Tools will basically catch up to Windows in revenue this year and gets the highest multiple of any Microsoft business. Windows is the median business.

Sherlund, the once and future axe on Microsoft, weighs in on taking the company private (maybe Dell actually is an innovator and trailblazer…):

“I’d like to think you could make something happen, but the enterprise value is $200 billion. That’s a pretty big company.”

But another Sherlund comment really makes the case for breakup:

It’s all about Office. There’s so much they could do to sell Office, but Microsoft is focused on trying to sell the Windows. Office is Microsoft’s anchor. How do you compete with Google‘s (GOOG) Android? The hardware guys can produce commodity tablets in China. The lever for Microsoft is Office. But they should deliver office on alternative platforms as well. You would hurt Windows 8 traction, but where is your better revenue opportunity? There is going to be a point in time where Windows has to stand on its own because we are missing an opportunity for a big annuity revenue stream. People are learning Evernote and Dropbox. Microsoft should be pulling Skype and Yammer sales through Office.

I have always believed the Office business was Microsoft’s to lose, as opposed to some competitor being able to take it from them. But if the rumors of Office for iOS not coming until 2014 are to be believed, they seem determined to lose it. I find it difficult to believe the development hasn’t been done for a while, so it is hard to know whether it is an issue of sitting on it to try to help Windows get a tablet foothold and/or not wanting to share 30% of revenues with Apple (the Office 365 subscription model with free clients being the obvious path out of this, but it hasn’t achieved the necessary volumes to make this work well). Office is the bigger business, but Windows comes first at Microsoft and will continue to as long as they reside under the same roof.

Pushing through the strategy tax cut at Microsoft would solve a lot of problems for SteveB.

(Interesting that though the stock is down over 4% today, it is only back to Monday’s price and is still at a six month high. Makes you wonder if the insider trading game that is Wall Street knows something about next week’s earnings).

2 thoughts on “A Very Targeted Tax Cut

  1. Zigurd

    It’s not just Windows 8, it’s Windows 8 requirements that attempt to push PC makers into making significantly more expensive PCs, and customers don’t see value in that additional expense.

    But the core problem is that Microsoft made a big strategic decision not to proceed on two tracks: A new OS for mobile/touch/media devices, and continuing to develop Windows for PCs. That makes Microsoft hard to break up, change management, etc. It’s a bunker mentality encoded in a technology choice.

    Throw the content publishers under the bus and disrupt that business, get serious about providing an alternative to Google’s Web ecosystem, make a new OS, make a robust, performant Windows, and highlight enterprise technologies until the new consumer products contribute to revenues.

  2. Charles Fitzgerald Post author

    Zigurd,

    I don’t know about the hardware requirements, but you can get a sub-$300 Windows 8 laptop that doesn’t completely suck. But it sucks for the OEM if netbook pricing is the new norm. Microsoft is hoping the next wave of OEM hardware is going to be a lot more compelling. We’ll see.

    On the two OS strategy, that is the path Microsoft has gone down with Windows Phone 7 (and predecessors), but there are a ton of things pushing them to single OS/app model across PC/tablet/phone – developer leverage, economic efficiency, etc. Apple gets this efficiency today while Microsoft will spend more time getting to this as opposed to delivering customer value. I don’t think Windows’ problem is being robust and performant.

    Ironically, Microsoft did the opposite of what it has historically done (Windows PC first, new market as bolt-on to Windows); with Windows 8 they optimized for the new market and undermined the traditional PC market. With no tablet traction, it is the worst of all worlds. The big question is whether Windows Blue will be pragmatic or a continuation of the previous absolutist course.

    I’m less optimistic about the conglomerate model. The last ten years show management has spent its time fixing one crisis after another and not leading. I think the businesses do better without the overhead and strategy taxes, especially Office and Server & Tools which now look like the majority of MSFT market cap. These businesses get sublimated to Windows in the conglomerate model (the new MS corporate logo is exhibit one for this argument).

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