Event: MSFT reports its fiscal Q1 earnings tomorrow after the close. The options market is implying about a 4% one day move, which is below the 4 qtr avg of about 4.75% (skewed by the 11.5% move lower last quarter), but in line with the 8 qtr avg of about 4%.
Sentiment: Wall Street analysts are neutral on the stock, with 17 Buys, 24 Holds and 2 Sells, with an average 12 month price target of around $35.60. The stock is up 27% year-to-date, but still trading at the same price as it did in 2001.
Options Open Interest: Open interest is skewed to calls over puts by a ratio of 1.5 to 1. The 1 month average volume has also been skewed to calls over puts by the same 1.5 to 1 ratio. The bulk of the outstanding options volume is in Jan14 and Jan15, where the 35 strike calls have the most open interest. Shorter-dated, the Nov 35 strike calls have over 80k of open interest.
Price Action / Technicals: MSFT did break out to a new 5 year high in the spring of 2013, but the breakout had no follow through. The stock has been stuck between 31 and 35 for the past 6 months:
The $31-$32 area was strong resistance and is now strong support. But the stock’s failure above $35 on multiple occasions over the past 6 months has a good number of buyers looking to sell around that level on any pop. The high of the year is $36.43.
Volatility: November vol is approaching 26, which is the high end of it’s range over the past 2 years. The IV tends to drop to the mid to high teens following earnings.
Options are fairly dollar cheap considering some of the big swings the stock has had recently although those swings have all taken place within a range. So the options are essentially betting it stays within that range on an earnings gap.
Our View: MSFT is not a stock that we have been a fan of on a fundamental basis for some time, despite some recent success migrating users to Office 365, the company is feeling pressures in most businesses that rely on PC growth, while their mobile strategy becomes increasingly irrelevant despite the recent acquisition of NOK’s handset business.
As bond yields come in (10 yr Treasury yield almost back to 2.5%), MSFT’s 3.29% dividend yield should look attractive to some investors, as long as they don’t keep pissing away their $72 billion in net cash on lame acquisitions like Skype and NOK.
What investors are most concerned about is the management transition as the board looks to replace outgoing CEO Steve Ballmer. Rumors for front-runners for the spot have been sparse, but the most talked about name and the one that investors appear to be most excited about is the prospect that current Ford CEO Allan Mulally will take the job. It is my opinion that Mulally would be a very bad fit at MSFT despite his impressive success turning the beleaguered auto maker over the last few years. He is in his late 60s and spent his entire career at industrial companies, was at BA from 1969 until joining Ford in 2006. MSFT does not need an Old School Industrial Guy, they need some new energetic innovative blood. It is my view that if Mulally was named CEO the stock would decline 5-10% even if it saw an initial pop.
I’d be a seller of the stock closer to the 52 week highs around $36 and a buyer for the balance sheet, buyback and dividend yield around $30 and the potential for a turnaround. At $34 it is in no mans land.