MSFT - Microsoft

[txlaw]

Yes, execution will be key, and I think it's fair to say that that has been lacking at MSFT lately compared to some of their competitors.  But I guess that's why they're doing the reorg and bringing in new blood.

 

I hadn't seen the presentation and transcript before I made my first long post.  I find Slide 22 very interesting. 

 

MSFT is setting a 15% market share target (like my hypothetical) in five years, which they believe will result in annual revenue of approximately $45 billion.  This means they're expecting (or conservatively projecting) an ASP of approximately $176 for each WinPhone.  Compare that to AAPL's current ASP of $581, which would have to be reduced a substantial percentage on an annual basis to reach the same number.  And even under a 5% operating margin scenario (very low compared to, say, an AAPL), they figure the NPV of the deal just for the phone sale business itself -- never mind the protection of Windows -- is more than the purchase price.

 

If you consider Skype as part of the devices acquisition -- so take a combined purchase price of $5 billion for NOK devices + $8.5 billion for Skype -- because having a FaceTime/Google Hangout/BBM equivalent is necessary for any serious OS provider, then that still works out to the deals paying for themselves.  Not even taking into consideration the protection of perhaps the greatest businesses the world has ever seen -- Windows. 

 

(Having said the above, I don't understand the price paid for Skype, although I do understand the strategic rationale for the acquisition.)

 

If MSFT can execute, then this is a fantastic deal.

 

msft spent $7b+ on the deal when you factor in cash paid to Nokia for licenses. msft has no idea what the smartphone business is going to look like in 2 years. but what they did here is buy themselves a low margin hardware device business. in fact the business is losing money now and the "plan" is for it to get to profitability in 3 years. The market asked why would you marry this terrible low margin hardware business to a high margin software company? the market is asking that question again today. Skype may be part of the d & s master plan, but it wasn't when they bought it. That's part of the problem. the plan seems to be throw stuff at the wall and go with what doesn't fall off.

 

Yeah, but I specifically stripped out the cash paid for licenses because most of that is for the software and services business lines that are linked to more than just mobile phones.

 

Skype was definitely part of the "master plan" when MSFT bought it.  The guys at MSFT are smart.  They understand the tech sector better than Mr. Market does.

[Guest valueInv]

This is in defense of those who are bashing Skype:

 

http://arstechnica.com/business/2013/09/skypes-secrets/

 

"msft has no idea what the smartphone business is going to look like in 2 years. but what they did here is bought themselves a low margin hardware device business. in fact the business is losing money now and the "plan" is for it to get to profitability in 3 years."

 

Really?  MSFT has been at the forefront of smartphone since 2000 with the Windows CE platform.  They were there before even Apple and Google got there.  Nokia started this whole smartphone market with the Nokia 9000 model.  Back the days of 2000, the platforms of choice were Windows CE and Symbian.  There were no iOS and no Android. 

 

The reason why all of you are talking about MSFT and smartphone now is because Apple has taken what Nokia and MSFT did back then and made it more ubiquitous for everyone with the App market.  Without the iOS Apps, Apple products are just wall-gardened devices.  Google took it to another level with the Open Source OS. 

 

Nokia will help them get smart really fast in the wireless space.  Look at what Motorola did for Google.  Mind you, Google paid $32BIL for MOT, a company at the time was also left for dead like Nokia.  Look at Motorola under Google today.

 

Yeah, look at Motorola under Google today. Look at how many lawsuits they have lost. Then look at how much money they lose every quarter.

[Guest wellmont]

I wouldn't strip it out. it's a payment to keep the mobile business viable. sure they're smart. smart people do dumb things all the time. smart people at msft actually thought KIN would be a good product. when they bought skype they had no insight at all that they would ever own the nokia mobile phone business. in that sense, it's not part of the master plan. it simply seemed like a good idea at the time. and because they've buried it and don't report the metrics, we don't know if it's a good idea now.

 

this is a defensive acquisition. once again msft was painted into a corner and had to respond by spending big bucks. NOK had leverage over them because they could have started moving to android. msft wanted the smartphone and tablet business. they never would have bought the dumb phone business or asha unless they were forced to take all or nothing. the market was valuing the nokia phone business at zero. msft paid $7b for it.

[Palantir]

Nokia became exclusive to WP about the time they got Skype.

[Guest wellmont]

Nokia became exclusive to WP about the time they got Skype.

 

that's a long way from buying the business three years later.

[txlaw]

I wouldn't strip it out. it's a payment to keep the mobile business viable. sure they're smart. smart people do dumb things all the time. smart people at msft actually thought KIN would be a good product. when they bought skype they had no insight at all that they would ever own the nokia mobile phone business. in that sense, it's not part of the master plan. it simply seemed like a good idea at the time. and because they've buried it and don't report the metrics, we don't know if it's a good idea now.

 

Well, including the entire acquisition price as part of the mobile device business line -- if you can even call it a separate business line -- is debatable.  I guess I just disagree with you there.

 

I do agree with you that MSFT didn't know they'd be owning Nokia when they bought Skype.  But that's irrelevant because MSFT was and has been focused on Windows.  Skype was about providing a feature that was necessary to have a competitive OS.  And I think they figured it was profitable and it had inroads into the developing world.  (Skype is a godsend for people who need to communicate with their relatives who are in far away places.)  Whether the price was too high is certainly debatable.  I think it was too high.  But, regardless, it was part of the master plan.

 

When MSFT bought Skype, they didn't know that no manufacturers other than NOK would succeed in bringing out any viable Windows Phone products.  Things have changed, and they have had to adapt. 

 

As to Kin, that was a problem of execution, not strategy or financial decision making.  That's been MSFT's problem all along.

 

this is a defensive acquisition. once again msft was painted into a corner and had to respond by spending big bucks. NOK had leverage over them because they could have started moving to android. msft wanted the smartphone and tablet business. they never would have bought the dumb phone business or asha unless they were forced to take all or nothing. the market was valuing the nokia phone business at zero. msft paid $7b for it.

 

I agree that this is a defensive acquisition.  MSFT had no choice because the only company that has had success with WinPhone is NOK. 

 

However, I still contend that that at the time of the MSFT/NOK exclusive partnership, MSFT had the upper hand, and NOK was making a huge gamble when it should have kept its options open.  But luckily for NOK, no other smartphone providers have succeeded whatsoever with Windows. 

 

Elop got lucky.  Ballmer was unlucky.  Or perhaps Microsoft shares part of the blame for not working more closely with the other hardware partners to make their Windows Phone devices successful.

[Myth465]

 

In five years owning a handset manufacturer will be the equivalent of owning a PC manufacturer today.

 

Very good point, another good point was there are plenty of Chinese suppliers who would crank out a fairly decent phone for low margins, without the employee headaches and overhead.

[Guest wellmont]

the smartphone business is headed to a zero margin business on hardware. Amazon Google and Xiaomi are already there or will be soon. nokia/msft certainly is not prepared for that.

[Palantir]

If MS controls the hardware and the software, it won't be a zero margin business. It's only a zero margin if the OS is licensed out which commoditizes the hardware, not so if the hardware and software are integrated.

 

Even if it becomes a zero margin business, MS can still make money on the services.

 

 

 

[Guest wellmont]

noted Hedge Fund Manager John Jacobson wants outsider.

 

wsj

We believed Microsoft’s independent directors had become more open to shareholders’ input, as evidenced by the CEO change and their willingness, albeit reluctantly, to give ValueAct a board seat...However, the facts clearly suggest that the Board choreographed the timing of the Nokia deal to both mislead and silence a well-respected investor, and shareholders have every right to be irate. I have an enormous amount of confidence in ValueAct’s ability to help Microsoft chart a new course which starts with finding a CEO from outside the company—not Elop, and one can only hope that the Board will act in good faith to serve the interests of the company’s owners.

[bargainman]

I haven't seen it mentioned so thought I would.  Just FYI Elop orchestrated the sale of Macromedia to Adobe.  We all know what happened with that ordeal.  I've heard he was a polarizing figure, and there was that series of articles about how he destroyed billions in revenue by writing the burning platform memo.

[petec]

 

problem is once msft does a big acquisition they simply stop reporting how it's doing. there has been zero financial disclosure measuring the performance of skype. they just bury it inside a big division and nobody asks about it. My guess is that it still isn't profitable, or only marginally so. Buffett would never think of spending $8b on something, then never again report how it's doing after he bought it.

 

That's because Buffet buys standalone companies.  Skype, to me, was bought to add functionality to existing products and to complement the envisioned suite of future ones.  I don't see, therefore, how its financials could sensibly be reported.  Personally I can see the rationale but I can see why people can't.

 

that doesn't obviate the need to report to shareholders how $8b of their money is being spent. you don't just spend and forget. well I guess you do if you're a tech company and can just bury the business you bought. it's exactly what bbry did with qnx. spent $200m on it and then buried it in their software and services business. But keep in mind, this is not shareholder friendly reporting, and certainly not shareholder friendly capital allocation. not a surprise that both companies under perform. msft will have a hard time hiding the performance of the nokia handset business.

 

It doesn't obviate the need, it makes it impossible.  If Skype strengthens other products, how do you separate out its financials?  As someone else said, Skype was essentially R&D.  I don't think MSFT should be breaking out returns on individual R&D projects either, despite spending more on R&D than deals.

[petec]

ASPs for Windows Phones according to Nokia are about $250 USD.  iPhones are about $580.

 

I'm going to stick with price as the leading driver.  Probably not many high end Nokias getting out the door with those numbers.

 

Sure - but that is where a lot of the volume is and if they can be profitable selling 50m devices at $250, good for them.  I'd worry more about Apple on that basis, if the devices are similar in capability.

 

I tend to agree with you there.  It's great if they can be profitable at $250 ASP.  It's also bad for Apple to have competition at the low end.

 

I think the challenge is going up market, where buyers are more sophisticated.  Or on the flip side, as sophisticated buyers start questioning the value of a $600 vs. a $400 phone, the strengths of the ecosystem will play a larger part in the decision.  That is, hardware being equal, a $400 Android phone is a better buy than a $400 Windows Phone because of platform support.

 

What I'm saying is, if Microsoft can't close the ecosystem gap quickly, then they will always be playing the lowest price game.  When iPhone ASPs move down to $500, it could require Nokia ASPs to move to $200.

 

Ah, understood.  Different target customer though - no-one looking at a $250 phone is suddenly going to buy a $500 phone because it has come down from $550.  But I take the point - ultimately this is a highly competitive market.  I just think that as volumes keep growing slowly, and as they fill in key gaps in the app ecosystem, they can build a viable company.  And if they execute well in capturing 'the next billion' and in having the app ecosystem that *that* customer base needs, a very profitable one.  Only time will tell.

[Myth465]

You guys are crazy if you think Skype couldnt be built for less than a few hundred million.

Facetime, Hangouts - not costing $7 billion each.

 

How is a feature in a platform worth $7 billion.

You pay that kind of money for something that generates a return. Not for merely an App or R&D to feel a product line hole. Hell they could have bought Rebtel (which I prefer) for no where near that. Where I am from $7 billion is a bit more than pocket change, and Skype was not a must have app....

 

Do you guys honestly think anyone is doing anything with Skype because of MSFT or vice versa, I would bet almost no one has changed their phone or PC OS habits because MSFT bought this app. This reminds me of Ebay thinking sellers would of course want to chat with each other via Skype.

 

Even if something comes out of Skype. INMO they could have replicated hangout, talk, facetime, ect. for less than a few hundred million dollars. People dont choose these platforms for these apps, they are just nice bonuses. The platform are chosen based on price, coolness, and stickiness inmo.

 

----

 

Also everyone is ignoring the chicken and egg situation MSFT is in. No one builds apps for a platform trending 2%, and no one goes to a platform without apps. Apps start on IOS, get ported to Android, and maybe go to MSFT and BBM when they arent as hot anymore. I dont see a solution to this.

[Guest wellmont]

You guys are crazy if you think Skype couldnt be built for less than a few hundred million.

Facetime, Hangouts - not costing $7 billion each.

 

How is a feature in a platform worth $7 billion.

You pay that kind of money for something that generates a return. Not for merely an App or R&D to feel a product line hole. Hell they could have bought Rebtel (which I prefer) for no where near that. Where I am from $7 billion is a bit more than pocket change, and Skype was not a must have app....

 

Do you guys honestly think anyone is doing anything with Skype because of MSFT or vice versa, I would bet almost no one has changed their phone or PC OS habits because MSFT bought this app. This reminds me of Ebay thinking sellers would of course want to chat with each other via Skype.

 

Even if something comes out of Skype. INMO they could have replicated hangout, talk, facetime, ect. for less than a few hundred million dollars. People dont choose these platforms for these apps, they are just nice bonuses. The platform are chosen based on price, coolness, and stickiness inmo.

 

exactly. saying this is r & d is revisionist history. $8b is not chump change. even for msft. And even if you consider skype as r & d, that means earnings are vastly overstated. which kinda makes sense given how low msft trades on a p/e basis.

 

ps: business reporting is quantitative. there is no room for wishy-washy language like "strengthen other products". that's not measurable. msft knows exactly how well skype is doing financially. it speaks volumes that they don't tell us.

[Palantir]

8B is the wrong figure, given that there is a 30% tax, the real opportunity cost is 5.6B. How much would it cost to reconstruct Skype with its what 300 million users? Great if you can put a precise figure on it.

[Palantir]

I'd like to see MSFT just release three phones, "Lumia 5, Lumia 7, and Lumia 9" with prices of 150, 350, and 550 which would cover the entire market, and the highest end phone would still be cheaper than the iP5.

 

 

I firmly believe MS can make a profit doing this. These are some really nice looking devices IMO.

[petec]

I doubt Skype's user base could have been replicated for a few hundred million, but I have no way to prove it.  Either way, I am not arguing about what MSFT paid, but about whether the value is well represented by Skype's standalone financials, which I doubt. 

 

I would also point out that even if Skype standalone is earning $800m net profit, which would mean they paid 10x, which arguably would make it a good deal, it would only be generating 3.6% of MSFT's net profit.  If you think they ought to break that out then we simply disagree on the level of granularity management teams should provide to shareholders.

 

I do agree that MSFT's earnings are understated if we consider acquisitions to be R&D. 

[Guest wellmont]

8B is the wrong figure, given that there is a 30% tax, the real opportunity cost is 5.6B. How much would it cost to reconstruct Skype with its what 300 million users? Great if you can put a precise figure on it.

 

600 million "eye balls" is not a metric shareholders care about. they care about revenue and profit. most of those users don't pay anything to use skype. i don't know if you want to "reconstruct" a product where most of your users don't pay anything to use the service.

[petec]

8B is the wrong figure, given that there is a 30% tax, the real opportunity cost is 5.6B. How much would it cost to reconstruct Skype with its what 300 million users? Great if you can put a precise figure on it.

 

600 million "eye balls" is not a metric shareholders care about. they care about revenue and profit. most of those users don't pay anything to use skype. i don't know if you want to "reconstruct" a product where most of your users don't pay anything to use the service.

 

Well - they care about net present value.  And I find it hard to believe that NPV is not at all related to the number of users, paying or otherwise.

[Myth465]

Whats a userbase worth if you cant turn a profit on it.

Why have the userbase, when they can have an app on your platform at no cost to you.

 

I have an Iphone, and an Andriod device - Skype (and Rebtel) are on both. What does MSFT gain by owning this app at the price of $8 billion or $5.6 billion. I would personally have left the money in the bank earning 2% to 4% overseas. I would guess that would generate a higher return than Skype ever would. How has this magical userbase helped MS in Mobile. How did it help Ebay. Paying money just because alot of people use something for little to no money doesnt seem like a great rationale.

 

Also why do you guys feel comfortable saying MSFT can piss away money / earnings because they have alot of it. What kind of argument is that, and the opertunity cost is having $8 billion in Ireland not $5.6. That same money could have been used to buy Nokia tax free.

 

With these arguments why not just buy every hot app for PC and Mobile. They all have growing userbases, and MSFT has alot of money so its a rounding error for them to pay millions or billions for Tinder, Whatsapp, and Snap Chat, ect.

 

Sorry about the sarcasm, but I just cant understand these arguments on a value investing forum. Nokia may or may not work, but $8 billion or $5.6 billion for an App, a feature, or R&D was not rational and will probably end in a write down.

[petec]

Whats a userbase worth if you cant turn a profit on it.

Why have the userbase, when they can have an app on your platform at no cost to you.

 

I have an Iphone, and an Andriod device - Skype (and Rebtel) are on both. What does MSFT gain by owning this app at the price of $8 billion or $5.6 billion. I would personally have left the money in the bank earning 2% to 4% overseas. I would guess that would generate a higher return than Skype ever would. How has this magical userbase helped MS in Mobile. How did it help Ebay. Paying money just because alot of people use something for little to no money doesnt seem like a great rationale.

 

Also why do you guys feel comfortable saying MSFT can piss away money / earnings because they have alot of it. What kind of argument is that, and the opertunity cost is having $8 billion in Ireland not $5.6. That same money could have been used to buy Nokia tax free.

 

With these arguments why not just buy every hot app for PC and Mobile. They all have growing userbases, and MSFT has alot of money so its a rounding error for them to pay millions or billions for Tinder, Whatsapp, and Snap Chat, ect.

 

Sorry about the sarcasm, but I just cant understand these arguments on a value investing forum. Nokia may or may not work, but $8 billion or $5.6 billion for an App, a feature, or R&D was not rational and will probably end in a write down.

 

A userbase is worth nothing if you can't turn a profit on it.  But I think there may be ways to monetise Skype other than by charging the users, rather like Google may well extract huge value from Android without actually charging for it.  And by the way, I don't think it is mobile that gets helped by Skype.

 

I also did not mean to imply that MSFT can waste cash because they have a lot.  I think they probably overpaid for Skype.  My argument was that they shouldn't be expected to break out every tiny little business they have in their reporting.

 

As for this being a value forum, this propensity to overpay is just something I discount in the valuation!

[Guest wellmont]

nobody said break it out. I did say more disclosure on how that $8b you spent is doing. you can be sure if it was doing well they would shout it from the rooftops.

[Palantir]

^I repeat, it is NOT 8B dollars, it is 5.6B, you keep ignoring my point.

 

How do you expect to make a profit if you don't have the userbase? You need to first get people to use your service before you can monetize it.

 

This is internet services, not selling Coca Cola. Internet services usually dont make any money in the beginning.

[Palantir]

Sorry about the sarcasm, but I just cant understand these arguments on a value investing forum. Nokia may or may not work, but $8 billion or $5.6 billion for an App, a feature, or R&D was not rational and will probably end in a write down.

 

It is not relevant whether this is a value forum or not, MS's success has nothing to do with what we believe. MS is not investing in this project because they are immediately going to extract cash flows out of it, it is a form of R&D to add a product or service.