New Trade MSFT: Expecting a Soft Upgrade Cycle

by Dan August 22, 2012 2:24 pm • Commentary

MSFT got out of the gates like a rocket ship in 2012, at one point up almost 27% in March and April.  Much of this enthusiasm in my opinion was a flight to safety by investors looking for companies with impenetrable balance sheets, cheap valuation, stable growth, a healthy dividend yield and most importantly an impending product cycle.

MSFT checks all of those boxes with expected earnings of ~11% for the next 3 fiscal years, PE well below market multiple and below it’s expected earnings growth rate, dividend yield of about 2.6% which places it at the high end of most large cap tech companies, and the expected launch of Windows 8 at some point in late Oct.  

MY VIEW:  The stock appears to be in a bit of a holding pattern as investors await fiscal forward guidance on their fiscal Q1 call scheduled for Oct 18th.  The forward guidance will likely be the most important data point as consensus expects fiscal Q1 earnings to be down 10% yoy in front of expected push-outs of orders in front of Windows8 release.

What analysts will have a hard time getting their arms around is whether this quarter’s weak PC environment was more macro driven, or a product of delayed purchases.  Dell told us last night that PCs, specially to consumers is very weak, they pointed to consumers buying cheaper machines, but also for the 2nd qtr in a row blamed the macro environment.  HPQ likely to echo the same on tonight’s earnings call.

Technically the chart looks tired and forming what appears to me a bearish triangle.  MSFT’s inability to make an attempt at a new high as the SPX just did leads me to want to look for bearish structures to express this view.

[caption id="attachment_15894" align="aligncenter" width="589" caption="MSFT 2 yr chart from Bloomberg"][/caption]


I guess I would add one last point, MSFT  is going all in on the mobile side, with their smartphone partnership with soon to be extinct NOK, and their recently released Surface tablet.  Their insistence to compete with their very important OEM partners especially in the fast growing tablet spaces suggests that this Operating System upgrade could be very different than those past. I WANT TO FADE ANY ENTHUSIASM INTO THIS RELEASE.  Given the continued cannibalization of PCs by tablets, and MSFT’s challenged positioning relative to AAPL & GOOG and their potential to alienate hardware makers could make this upgrade cycle different to ones past.  Enis had a nice trade in front of their past earnings release and had some interesting thoughts on the name back in July (read here).

TRADE: MSFT ($30.57) Bought Oct 30/28 Put Spread for .48

-Bought 1 Oct 30 Put for .75

-Sold 1 Oct 28 Put at .27

Break-Even on Oct Expiration:

-Profits btwn 29.52 and 28, make up to 1.52, max gain of 1.52 at 28 or below.

-Losses of up to .48 btwn 29.52 and 30, with max loss of .48 above


Trade Rationale:  I want to define my risk, and I am starting with half the position size than I normally would as there is plenty of time to get in front of this trade, and the stock would likely trade higher, possibly back to 32 if the SPX was to make sustained breakout.   I am convicted on the short thesis, timing will be the real issue, any QE induced rally will likely lift all boats which is why I prefer Put Spreads to naked short stock, I am risking what I am willing to lose.