This page has been archived and commenting is disabled.
Microsoft Just Pulled Another “Microsoft” with its Purchase of Skype
When I wake up in the morning and check news for the companies I own, I worry. I don’t worry that my companies missed their quarterly guidance by a few pennies – running a business is an art, and things don’t usually work out in a precise, linear fashion. The companies that have a “deliver the quarter” culture often just play their financial statements as a musical instrument. No, I am not worried about that. What worries me is that a company in my portfolio will pull a “Microsoft” – announce a stupendous, “transformative” acquisition, like the $48 billion takeover of Yahoo! that Microsoft announced in 2008, but that Yahoo!’s management was too … (fill in the blank) to accept. (I spent some time looking at Yahoo! last week. Its stock is at $18, almost half the price that Microsoft offered, and I find the company only mildly undervalued if you give a significant value to the assets alibaba.com and Alibaba Group that Yahoo! acquired in 2006 and which were not worth nearly as much in 2008.)
Today, while in NYC still playing catchup with the jet lag from the European trip, I read a headline: “Microsoft is near a deal to buy Skype for $8.5 billion.” Microsoft is pulling another “Microsoft”, though this time it may actually succeed. Private equity and eBay, which still owns 30% of Skype, may actually sell, unless Google or someone else rushes in with a competitive bid.
Microsoft had the chance to buy Skype for a long, long time. eBay would have parted with Skype for a fraction of $8.5 billion as recently as 2009; in fact it did, it sold 70% of it to private equity, valuing Skype at $2.8 billion, a third of what Microsoft is offering today. Skype only generates $800 million in revenues, putting today’s price tag at over 10x revenues and some much, much larger multiple of earnings – a very lofty valuation.
Microsoft falls into the broad category of high-quality stocks that were incredibly expensive in 1999 and have not gone anywhere since (and have often declined, as is the case with Microsoft). But most stocks in that category – take Wal-Mart, Cisco, Medtronic, etc. – have seen their earnings and revenues triple and P/E’s collapse. So before we run to crucify the management of these companies and call them “value traps,” we should actually take a careful look at their fundamental performance. Management did what it was hired to do: it increased shareholder value by growing the business while maintaining or increasing the moat. It is the shareholders who overpaid for those stocks in the ’90s. Management is not at fault for that, human greed is.
However, ten years ago Microsoft was an icon, it was a star, it was the company that any self-respecting software engineer wanted to work for. Today, with current management’s help, it is slowly becoming a has-been. In fact, when I think of Microsoft I often think of a quote from Warren Buffett (Bill Gates’ best friend), who said he wants to own a company whose business is so good and whose moat (competitive advantage) is so wide that it could be run by a monkey, because someday it will be. Buffett, though he’s the Oracle of Omaha and all, probably did not know at the time that he was talking about Microsoft (bing it: “Steve Ballmer Monkey“).
Today Microsoft is suffering from the too-successful company syndrome: it was too successful for too long, and the success corrupted management thinking into a belief in entitlement. Management started to forget what made them successful in the first place –hard work, paranoia about competition, and a little bit of luck (which is random; one could hope for it but never depend on it).
I vividly remember in 2007 Apple was introducing its iPhone, a touch phone, and Microsoft was introducing a touch table (see it for yourself). Steve Ballmer publicly dismissed the iPhone as a very expensive gadget. Today, after Microsoft’s market share in cell phones went from respectable to nonexistent, and with the iPad (a device that is a barely a year old) killing netbook sales, Microsoft is a shadow of its former self. The number of consumer gadgets that have the Apple insignia is rising at a much faster rate than Microsoft’s (my family has two iPhones, two iPods, one iPad – I am writing this on it – one Mac mini, and two Windows PCs).
The moat is still there; Microsoft still dominates in desktops, servers, productivity (office), and even gaming; and that is why, despite Mr. Ballmer antics, earnings are much higher today than they were 10 years ago. But when a company is run by a proverbial Buffett’s monkey, no matter how good the business is, the moat will grow shallow and then cease to exist. Even five years ago one would have been fairly comfortable projecting rising Microsoft cash flows ten, fifteen years out. That confidence is much lower today.
From my conversations, people who work for Microsoft love the company but hate the environment. Microsoft has become a highly bureacratic, extremely political timeocracy. (A timeocracy is the opposite of a meritocracy: people get promoted not based on their talent or performance (merit), but on the time they’ve been at the company. This type of environment is great for Google and Apple, as it creates a fertile ground from which to cherry-pick talent. It is very difficult to fire a person at Microsoft who doesn’t perform (I’ve heard it takes a year to dump someone). This is good if you a nonperformer but horrible for the company, as it creates an undynamic, zombie-state working environment with horrible productivity. Managers are afraid to hire full-time workers and thus hire temps. In other words, to some degree Microsoft is becoming the un-unionized GM of the West Coast (though in all fairness, due to its moat, it still produces a 30% return on capital, high margins, and a healthy balance sheet).
Microsoft’s past success, $40 billion net-cash balance sheet, and the $20-plus billion in cash it generates each year gives management a false sense of security. But success has it side effects. It takes away the need to be paranoid, competition is dismissed, focus is lost – there is no project (even the touch table) that is not off limits when you think you have limitless resources. Steve Jobs once said that focus is not what you choose to do, it is often what you choose not to do. Cisco’s three-decade success also went to management’s head; however, CEO John Chambers woke up to that a few weeks ago and wrote a memo to employees admitting his mistakes and outlining steps to refocus the company.
It is difficult for management to admit their mistakes (they are human, and we are not good at that), and for the board to fire current management while the company is increasing its revenues and earnings. A company needs to hit the proverbial wall for that to happen. Microsoft is far from that wall.
Instead, Microsoft is making another acquisition, and Skype will likely be as wasteful as the ones it did in the past. I am fairly sure, a few years down the road, Microsoft will take a “one”-time charge to write down the goodwill for this acquisition, not unlike eBay a few years ago, after their purchase of Skype.
Skype has a terrific product, which I use a lot. My son plays chess with my father on Skype daily (despite my father living only seven miles away). But unless I use Skype to make phone calls (which I do when I travel outside of the US), Skype makes no money on me as a customer. I find that I use Skype as a VoIP product less and less when I travel outside of the US, because almost everyone I want to talk to has Skype on their phone or computer (this is how I communicate with my partner Mike when I am outside the US). The minute Skype decides to start charging for video-to-video service I’ll switch to another free provider and so will my friends and relatives (ironically, we’ve been conditioned that video-to-video communication should be free).
So why, after everything I wrote, do I masochistically own shares of Microsoft? Because the business is still too good and the stock is incredibly cheap. Microsoft is trading at about eight times next year’s earnings if you take out cash. However, as I write this I pause. What if Microsoft (Steve Ballmer, to be exact) keeps pulling “Microsofts” and continues to buy the Skypes of the world? With the Skype acquisition Ballmer will likely destroy 60 cents of Microsoft’s value. ($8.5 billion roughly equates to $1 per share for Microsoft. Skype is worth closer to $3 billion, 40 cents a share.). In our estimate Microsoft is worth around the mid-30s, so with this upside we can tolerate a few Skypes, but not many. I truly hope that other shareholders and employees start a jasmine revolution in Microsoft and vote Steve Ballmer out of office. But that is only a dream.
P.S. Despite my being critical of Steve Ballmer, the deal Microsoft signed with Nokia was brilliant. Microsoft is a software company and doesn’t make hardware; its partners do. Though in the bulky world of PCs and laptops that setup did not hinder Microsoft, it does now. Apple’s control of both hardware and software allows the iPad to have a 10-hour battery life. On my flight from Prague to NYC my Dell ran out of juice in less than 2 hours, and I had to use the iPad for the rest of the trip (an external keyboard helps a lot).
Nokia’s new CEO came from Microsoft. My friend Tero Kuittenen described him as a Manchurian candidate: it appears almost as if he was implanted into Nokia by Microsoft – the Microsoft-Nokia deal is by far more favorable to Microsoft than Nokia. The new CEO looked at Nokia’s operating systems (Symbian and MeGo) in development and realized he didn’t have many options other than creating an alliance with Microsoft. (Go figure!) Nokia could have used Google’s Android, which is free, but it is difficult to differentiate in that crowded space. So Nokia hung its future on the Windows operating system. And it makes logical sense that the alliance will go beyond cell phones to tablets; after all, as Apple taught us, a tablet is a big cell phone, not a small laptop. Despite dropping the ball on the operating system front, Nokia is the king of cell phone hardware. Working very closely with Nokia will provide Microsoft a more holistic software-hardware design platform and give Microsoft a fair chance to come up with a decent, iPad-level tablet.
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email, click here or read his articles here.
- advertisements -
Remember when Cramer went nuts and started bringing in psychics. What was the message over and over. Would buy something that made it a lot of money. Would buy something that made it a lot of money. That's all these people know how to do is buy something.
Skype is the purchase of a slave ship full of slaves.The employees will be jumping ship as soon as it goes through and nobody will be able to take delivery.
I run a low cost monthly Skype subscription for any long distance calls I want to make outside of my mobile phone plan. My first thought was; how is microsoft going to ruin Skype?
Also, while MS always got over on their monopoly, they hardly even had to work at becoming a standard, they grabbed the ring early on with little to risk, and IBM handed them the gift of being stupid enough to let their machines be cloned with MS sofware on them, its not MS even set that up, it just happen they became the standard. They were good moat diggers tho, they claimed in trial that you couldn't take Explorer off a desktop without screwing up rest of their software til IT guy in courtroom pointed out the un-install feature in Windows :)
At least Google is earning their monopoly with talent and foresight. They did not just happen to be the OS on a phone system that went global, rather they used their war chest to give their product away for free, to make phone guys profitable, they are working hard to become standard. MS never had to give product away for free to establish DOS, Windows as standards, they became the standards all while making huge money the whole way up..they didn't get around to giving things away to become the standard until Explorer, Xbox.
Microsoft looks a little like the US: still thinks it has an empire, and operates by buying or bullying all others. I can tell you they're already jamming their blood funnel into Yahoo after infusing $1 billion in a "collaborative effort". Looks like a bunch of mgmt are now Manchurian Candidates. Many old timers are defecting for greener pastures.
Apple creates a closed system that is vertically integrated and monopolistic internally (sort of like Exxon but much prettier) but they face competition.
Steve Jobs may have never truly invented anything but he had the power and vision to get Apple to do things Microsoft, Nokia, Rim, MP3 manfacturers never did...he went with Adobe and made simple text a whole lot better on computers, he went with GUI, how many years before MS did that? Only after Apple did it and did it well enough to be popular, MS brought out Windows kicking and screaming only when forced...MS could have been ahead of curve. And how many MP3s existed before Apple improved with Ipods. While Apple tried and failed with Newton and they did not invent smart phones nor multi-touch screens...they forged the way and were the first to do smart phones with touch screens that worked...screen locks, accelerometer to give touch screen back when away from cheek, seem trivial but Jobs pushed the envelop. Yes he copied, but he was a guy with design sense and vision that had power incorporate stuff no other CEO had power or daring to put into their electronics..
Compared that to what has MS done. What single thing have they copied and improved much at all? Apple forced Windows. Zune was a late copy of Ipod with little better. Xbox? they sell it at loss for long time. Did Excel, Word break any new ground, take an existing idea and forward it in some important way like Apple/Jobs?
And don't get me started on internet...they did Explorer only long after Netscape had created the web as something interesting and useful ot everyday people, so Explorer used to wipe out Netscape but it had nothing much better, just a monopoly and muscle to bundle Explorer.
They did not even encourage employees to get on internet at first, saw it as competition. They were right but who is so lacking in vision not to run along side train and hop on rather than jump out of way at last second and then try to build your own train to catch up. Their MSN was hardly innovative and they let Yahoo and then Google clean their clock on search. They have created/forwarded a little something with Bing but not much.
MS always always got over on their monopoly. I asked a friend of mine, an MBA, that worked at MS in the late 80s why their were such high profits on software, especially in Europe if there was not a monopoly..he responded they had a low cost of goods due to technology innovations, so they got fat margins. He was serious...I laughed so hard, I said textiles had a low cost of goods due to high tech looms also, but you didn't see fat margins on those...
I dumped my Skype account when Google introduced their "Call Phone" app for Gmail. It works as good as Skype ever did for phone calls, but for free. And video chat is everywhere these days, including Gmail. I wish M$ luck making money with Skype.
Hopefully for Microsoft, their lawyers are smarter than Ebay's, who screwed the pooch and neglected to include the intellectual property rights in their original Skype acquisition.
This deal seems like yet another example of money burning a hole in a CEO's pocket, itching to do a deal for the sake of doing a deal. Maybe they'll integrate Skype into their productivity software and add some value that way, but it sure seems like Skype will become a business school case study in bad acquisitions, twice.
The tax savings is enourmous for MSFT with this purchase. No need to report int he USA.
exactly..skype is belgium hq. Tax equiv cost maybe 5.5b.
Screw this shitz. Just use UBUNTU. I forgot most Americans are stupid and can't and don;t know how to use short cut keys.
Ballmer just wants to nail down that $25 stock price for the next 5 or 6 years.
does the Ipad + cloud computing mean the end of the HD run PC?
I'm still pissed at Gates for destroying Word Perfect. Actual competition in software is still a work in progress.
+10000
One of the best.
I had the same thought yesterday: what's if after Skype Ballmer still feels "hungry" and keeps on buying? I too can tolerate a few small ones, but what if RIMM is next? What if they go after Yahoo once more time? and now the scairst thought: if they paid 8.5B for Skype, what would MSFT pay for Zynga or Twitter? 20B? 40B?
So, I came to a different conclusion: I'm not buying MSFT. Since their cash is dwindling, there's no chance for a juicy special dividend. And without a carrot of a one-time ginormous dividend or buyback that could give the stock $3-5 "bump" overnight, but there's an increased rist of dropping $3-5 if they buy soem overhyped, unprofitable crap.
I have a problem with the way Microsoft has been vilified in the past for supposed Monopolistic practices, while Apple gets away with having a strangle hold on the software and hardware for their platform. Not saying I am a fan of one company or the other, but there seems to be a huge double standard depending on your market leadership position.
Good luck with that, boring.
Now that Google chat includes video, or will soon, Skype will probably become obsolete anyway. Seems like a lot of money to spend on something that will never make that much in return.
MS has no innovative and creative brain power. All they got was lucky to have one product monopoly. They can only walk around. Copy other people's ideas, then put it in their products for free to kill off competitions. When they can't create stuff on their own, then they buy the competition out.
That is the only way I have seen MS run a business. I have yet be impressed by one single product made by MS. They just clone what is becoming popular out there.
The practice of using something existing isn't specific to Microsoft. Where do you think Apple got the new MacOS from? It was basically nothing more than the remnants of NextOS applied to Linux.
MacOS as in OSX is based on BSD Unix, not Linux. NextOS was also based on Berkeley unix (BSD).
Microsoft owns a Unix variant called Xenix, and used to run it on their campus, now everything is of course Windows, which may explain a lot of things.
Microsoft got lucky, I am continually underwhelmed by their products, especially the upgrades. What did Vista do that XP couldn't - except crash more frequently?
A stable operating system should be invisble to the user, it should get out of the way and let application software work. At the rate Microsoft is "improving" its software by adding more bloated code, it will no longer be practical to distribute its software on optical discs, unless they are Blu-ray.
Zune,Clippy, Vista - anybody see a trend?
Yo MP - you have lifted the cover off of the sewer cover. Windows is an inefficient OS as it operates above the kernal. Any changes to Windows requires more testing than NASA moonshot. That is why new MSFT products are typically so buggy.
APPL OS is written to the kernal. Much more efficient and testing time for modifications is cut in 1/2.
MSFT should have bought Redhat years ago, and revamped their OS, if they had real balls. But of course Gates and Ballmer knew they could screw the pooch for another 10 years before it all went down, rather than take a gamble on actually introducing something great.
MSFT may look cheap on a cashflow basis but there are growing threats (black swans?) to their monopolistic ball lock on corporate software systems because of their antiquated OS.
Touché. However, Apple created a huge business from that. APPL stock $346, MSFT $25.
Remember that Microsoft spent $400 million on WebTV after it had shipped something like a 1,000 units. It was supposed to be the game changer - integration of the television with the internet ... blah blah blah
People use Skype because it's free or low cost, and easy to use. Words not associated with Microsoft's vocabulary.
I suspect Microsoft's intentions are to bury Skype - if Facebook or Google got a hold of it who knows what would happen to the cash cow MS Office.
the common "denom" was SJ...
+ x86
by then AAPL WILL BE.....where???