Dueling Fools
Microsoft 2000
The Bull Rebuttal
By
My colleague has done a fair job of assessing some of the challenges facing Microsoft. In the corporate market, Sun and Linux pose viable threats. In the consumer market, AOL and Yahoo! are strong competitors. But even so, none of these companies has the wherewithal to derail Microsoft from playing a major role in providing software for the workplace of the future.
Exactly how big a role is anyone's guess. The bear and I could debate that one 'til we're blue in the face, and it wouldn't do any good. Predicting future revenue and cash flow is of some value, but it's still only a guess. What we do know is that Microsoft's corporate culture is blessed with an outsized dose of Type A personality. Years of success have allowed Microsoft to collect deep ranks of managerial talent, all of whom are trained in the specialized art of winning. You better believe that's a competitive advantage.
Often, companies are admired for certain "personal" traits. Like creativity at Apple, or innovation at Lucent's Bell Labs. Such attributes are admirable and praiseworthy, having almost a warm-and-fuzzy quality about them. Then there's Microsoft, whose most noteworthy trait is its ruthless business savvy. Hmmm, not so endearing, is it? But truth be told, a corporation is at root an economic animal. Market value isn't based on corporate image, but rather on the ability to generate free cash flow. And that's something Microsoft has almost unparalleled expertise in.
With $9 billion of the green stuff rolling in over the past 12 months, is it any wonder the company has trouble keeping a modest cash balance? Academics sometimes criticize Microsoft's cash surpluses, but I think it's simply a result of the company's awesome cash-generating abilities. In the past year, much of the excess cash has been deployed into strategic investments, such as May's $5 billion investment in AT&T. Microsoft's cash-flush and debt-free balance sheet is not only tangible evidence of success, but also an offensive weapon that allows the company to quickly obtain necessary technology through acquisitions and/or significant strategic investments.
When it comes to getting its hands on a good idea, Microsoft is willing to buy, build, or sometimes "borrow" in order to get the job done. To many a techie's chagrin, Microsoft has scaled the walls of corporate success with unparalleled speed based simply on the company's pragmatic know-how at playing the game of business better than anybody else. The rules of business are quite unique. Unlike in school, copying another's work is a regular part of business success. For whatever Microsoft has lacked in innovation, it's made up for it tenfold with the ability to spot a good idea and make it a commercial success faster and better than the next guy.
As the PC era transitions into the "PC Plus" era, I expect Microsoft will continue to exhibit that same scrappy determination to win. Corporate demand for software to manage information and expedite commerce should provide Microsoft with growth avenues throughout the next decade. My colleague suggested 15% annual earnings growth as a reasonable rate, but I think Bill Gates' team will surprise the financial community with more robust growth than that.
With $21 billion in revenues over the past year, Microsoft is a big company, but not altogether huge. For example, in the most recent ranking of the Fortune 500 by revenue, Microsoft was #109. With that perspective, it's not unreasonable for Microsoft to grow its revenues and free cash flow at a 20% rate over the next 10 years, provided solid execution. Then, if the stock market were to value Microsoft at 25x year 2009 free cash flow (which is less than the current 28x multiple to FCF for the S&P 500), Microsoft would provide shareholders with annual returns of approximately 15% based on a current price of $87 per share.
That's good enough for this Fool.
Next: The Bear Responds