A ten-year chart of Microsoft (MSFT) is not a pretty site. Excluding dividends, shares are down a little over 10%, and the PE has contracted from above 40 to, at times, below 10. In the same time period, Microsoft has gone from a Wall Street tech darling that dominated computing to a dinosaur, legacy tech-company. Regardless of how accurate such a description may be, investors have in droves fled to Apple (AAPL), which makes innovative consumer devices that have impressed the masses.
During this same time period, Microsoft has had a few wins, including Windows 7, continued excellence with its Office products, Xbox, and Kinect. Throughout the same period we’ve also seen the Zune, unsuccessful tablets, a weak mobile strategy, and Windows Vista. Clearly, it’s been a bit of a mixed bag. But at Valuentum, we look towards the future for profitable investments, and we think it looks pretty promising at Microsoft. With the company trading around $30, we think the company has meaningful upside and a very attractive dividend payout that should not only grow, but also protect investors from substantial downside.
We might be stating the obvious, but Microsoft’s mobile strategy hasn’t been good. While Apple decided to revolutionize the tablet by making it stylus-free, and all touch, Microsoft sat back and watched iPad become the tablet market.
While Research-In-Motion (RIMM) and Samsung ran to market with copycat products, (several hardware companies running Google’s (GOOG) Android Mobile OS), Microsoft has yet to release a similar product, even trailing Amazon (AMZN) in coming to market.
As far as smartphones go, Microsoft has been creating software for a long time, but it hasn’t really done much with it. It’s still a distant fourth place behind iOS, Android, and Blackberry. The company has yet to enter the market with a premium phone, although its Mango has been its closest attempt so far.
But it could get much better.
We actually don’t view this as a negative. While Apple grabbed the first mover advantage, we also think it has—by far—the most popular product on the market. It’s also the best. Research in Motion’s Playbook seems to be mostly collecting dust, Hewlett Packard (HP) already pulled out of the tablet market, as it could only sell them for a loss, and most Android tablets receive decent reviews, but don’t have the same appeal as the iPad. Amazon’s Kindle Fire seems to be selling reasonably well, but as Amazon noted, it is actually taking a loss on the product.
Ultimately, there’s no point for Microsoft to rush to market with a mediocre product, when it could take time to develop a better functioning, higher quality product running Windows 8. The firm may also time the release to coincide with the Windows 8 PC launch to grab consumers who end up liking the latest version of Windows, which is a divergence from previous products. Apple is the clear-cut winner thus far, but not everyone can afford an iPad, and we think Microsoft could grab those looking for lower price-points.
The smartphone market is a bit different. Several investors have speculated that Microsoft might buy Nokia (NOK), for whom they are the exclusive software provider, or even Research in Motion. Ultimately, we think Microsoft might prefer to remain hardware agnostic. It doesn’t have the expertise in manufacturing like other companies, and therefore, we think a hardware acquisition may be outside of their core competencies. However, with mounds of cash (over $50 billion), such a transformational move is not out of the realm of possibilities.
Regardless, we think there’s room for a third place (or new second place) player in the mobile phone space. For now, like tablets, Apple is the clear winner, but we do not think Android is a clear number two. Though Android is running neck-and-neck with Apple for market share, we don’t think people outside of the core Google fans are too excited about Android. Plus, we don’t think the Android platform is nearly as sticky as the iPhone. Aside from the fact that a lot of tech savvy consumers use Gmail, we don’t think switching costs to a Microsoft phone would be too high. If Microsoft can create a product that customers really want, the potential is enormous. We believe Android is a huge player only because it is on so many devices, not because it’s a great and sustainable platform.
Much like the Microsoft strategy, shareholders will need to remain patient. No one should expect an iPhone killer to show up tomorrow, but we think shareholders will be rewarded if they wait for this strategy to play out. In the meantime, Microsoft is returning huge amounts of cash to shareholders. With a payout ratio at about 30%, and a Valuentum Dividend Cushion in excess of 4, the company has a tremendous amount of room to increase dividends, assuming the core business continues to perform well, and the firm eventually become a player in the mobile computing world.