MorningWord 10/25/13: $MSFT Cloudy With a Chance of Mulally

by Dan October 25, 2013 9:30 am • Commentary

MorningWord 10/25/13:  Like most technology trends over the last decade, MSFT was late to the cloud, defending their dominance in desktop computing, with little acknowledgment of broad secular trends bombarding their turf.  It is fairly ironic that in Steve Ballmer’s twilight as MSFT’s CEO the company is now just starting to make dramatic progress (albeit off of a low base) in the Commercial Cloud, migrating old skool Office users to Office 365, recently showing growth in commercial seats of 135% year over year.  Last night the company reported better than expected fiscal Q1 results, and the stock is up 6% in the pre-market as none of the major business segments delivered results that were materially worse than expected, while others like the Cloud continue

The Cloud migration on the fundamental side will be one of the key factors driving the bullish investment thesis. Per Bernstein Research:

Commercial Cloud revenue was up 103% YoY, and Office 365 and Azure both grew triple digits. We understand that one out of four enterprise customers now use Office 365, and more than 75% of Office 365 customers have premium workloads. In addition, >75% of customers use more than 1 workload. Within the Commercial Cloud business, Microsoft saw margin expansion from scale benefits.

With today’s gains, MSFT is once again approaching the 52 week (and multi-year highs) made on July 16th of $36.42… what to do with it here?  The real risk in the short term is the board’s decision on Ballmer’s successor for CEO.  The higher the stock goes into, the greater potential disappointment.  In my opinion an internal candidate would be met with disappointed shareholders that could cost the stock 5-10% from current levels.  Yet one name widely rumored and thought about in the press and by analysts as a favorable choice, Alan Mulally, current CEO of Ford, in my mind would be a disaster for the company.  Per my preview from Wednesday (here):

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.

So my take, I would be surprised to see a break-out in the shares prior to some resolution to the management change. I stick by my thoughts in the earnings preview:

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.

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.

I guess I would add one last thing, if the company were to hire someone that investors could really get behind with an eye towards a meaningful reorganization and turnaround of MSFT’s future prospects, than the stock could go bonkers in the right market.  The chart below of MSFT since 1998, shows just how tightly wound the stock has been since the tech crash in 2000.  With the right CEO choice I suspect that entries btwn $25 and $30 will be hard to come by without a broad market correction, but likely a lay up entry level for years to come, while low $30s attractive with a shorter term time horizon.

MSFT since 1998 from Bloomberg
MSFT since 1998 from Bloomberg