New Trade MSFT: On The “Surface” This Company Looks Increasingly Screwed

by Dan October 26, 2012 2:04 pm • Commentary

Given the sentiment towards tech of late, and given MSFT’s recent and soon to be released product flops in the mobile space, I am shocked that MSFT’s stock is still up on the year.  See my comments/bearish trade from Aug below and my earnings preview/bearish trade from last week (here) , but we have not been a fan of the story, and if it weren’t for the pristine balance sheet, amazingly strong cash generation and 3.3% dividend yield, this stock would be “below the surface” so to speak, and certainly not still up on the year.

With the stock down 11% in a month, and 15% from the 52 week highs, this is not a great entry point to press the short, but looking at Ratio spreads for low premium could make a ton of sense.

Technically the chart is sitting on a massive support level at ~$28 but the next bit of bad news is likely to send the stock back to about the levels where it started the year when investors still had excitement about impending product cycles.

[caption id="attachment_18677" align="aligncenter" width="490" caption="MSFT 1 YR chart from Bloomberg"][/caption]

Well the products are dropping now, and they are falling like lead balloons.  The more products from Windows phones to Surface Tablets to Windows 8, the worse the reviews seem to be.  The realization that these products aren’t helping could send the stock lower in the coming months.

TRADE: MSFT ($28.05) Bought Jan ’13 26/24 1×2 Put Spread for .10

-Bought 1 MSFT Jan ’13 26 Put for .54

-Sold 2 MSFT Jan ’13 24 Puts for a total of .44 (.22 each)

Break-Even on Jan13 Expiration:

-Profits btwn 25.90 and 22.10, make up to 1.90, with max gain of 1.90 at 24.

-Losses of up to .10 btwn 25.90 and 26 and btwn 22 and 22.10, worst case scenario the stock is below 22 and I suffer losses above the premium that I paid for the ratio spread.  To be clear because I am  short 2 Jan 24 puts, so if the stock is below 24 I would be put the stock there, but I have made 1.90 on the Put Spread that I own, so that will offset the losses down to 22.10.

 

Trade Rationale:  As I said above, this may not be a great entry point to press the short here, but the ratio spread lines up to be very well, this spread as a very low delta, the Jan13 26 puts have about a 25 delta, and the 24s about .11, so it will take  fairly substantial move to make decent money, the goal for this spread that it does soon slowly over time.  The way I see it I am risking .10 to possibly make multiples of the premium outlay with a very small probability of losing more than the .10 that I spent.

So in Sum, not a particularly high probability trade, but fairly low risk for high potential payout.  I will look for higher probability bearish trades if the stock moves back to $29.

One last thing, by being net short an option on the spread, I have to be mindful of the margin implications.

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Trade Update Oct 12th, 2012 at 12:28pm:  With MSFT down 5% since initiating my bearish Put Spread back in Aug, I am now going to close the spread for a little more than a double prior to next week’s fiscal Q1 report on Oct 18th.  My view on the stock has not changed and will look for a different entry point and possibly a different structure to express this bearish view. There is a good bit of negative PC news in the name at the moment (INTC, AMD & HPQ negative pre-announcements), and with the stock smack dab in the middle of my strikes the risk/reward looks less compelling given the potential volatility of next week’s earnings event.

ACTION: Sold to Close MSFT ($28.96) Oct 30/28 Put Spread at 1.00 for a .52 gain

 

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Original Post Aug 22nd, 2012: New Trade MSFT: Expecting a Soft Upgrade Cycle

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.  [private]

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.