Microsoft Sheds Its "Ballmer Discount." What's Next?

Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.

U.S. stocks finally managed to string together two days of gains -- the first time since Aug. 1-2, as the S&P 500 (SNPINDEX: ^GSPC  ) rose 0.39% today. The narrower, price-weighted Dow Jones Industrial Average (DJINDICES: ^DJI  ) was up 0.31%.

Consistent with those gains, the CBOE Volatility Index (VOLATILITYINDICES: ^VIX  ) , Wall Street's "fear index," which fell 5.3% to close just below 14. (The VIX is calculated from S&P 500 option prices and reflects investor expectations for stock market volatility over the coming 30 days.)

The biggest contributor to today's gains in the S&P 500, the Dow, and the Nasdaq Composite Index was Microsoft (NASDAQ: MSFT  ) , on news that CEO Steve Ballmer will retire within the next 12 months. Microsoft shares had already done yeoman's work for the indices yesterday, being the biggest contributor to increases in the S&P 500 and the Nasdaq.

Yesterday, I presented the case for Microsoft articulated by Rick Sherlund, the Nomura analyst who had just upgraded the stock from "neutral" to "buy." His reasoning was that over the next six months, the potential for activist investor ValueAct to act as a catalyst for the shares trumped fundamentals. Beyond six months, Sherlund, went on to explain, the shares' valuation, at seven times free cash flow, provided a margin of safety against the deterioration of Microsoft's consumer businesses.

I don't think Sherlund was anticipating that ValueAct's activism would pay off this quickly or in this manner, as Microsoft announced today by press release that Ballmer will retire within a year, once the search for his successor is successful. The market was unequivocal in its reaction to the news, sending the shares up 7.3% (its biggest daily percentage gain in more than four years) and adding nearly $20 billion to the company's market value.

Back in mid-July, when the company announced a major corporate reorganization, I wrote:

My concern is rather more with Steve Ballmer himself: I don't think he has provided much evidence that he is the right person to continue leading Microsoft through another restructuring, if the company is to have any chance of joining the pack of tech front-runners.

Furthermore, the nature of the reorganization compounds an existing problem at Microsoft: It appears to strip divisional managers of their autonomy and to centralize power at the top level -- that is, with Ballmer. That doesn't exactly send a healthy message for a company that doesn't have a clearly articulated succession plan.

Where is a succession plan when you need one? I certainly wasn't the only person who was critical of Ballmer; frankly, I'm flabbergasted that he has lasted this long. As Nicholas Thompson pointed out for The New Yorker:

[H]e missed every major trend in technology. ... Microsoft missed social networking. It completely misjudged the iPhone and the iPad. It embraced complexity in product design just as everyone was turning toward simplicity.

Even without knowing who his successor will be, I think Ballmer's departure must be seen as a positive development for the company and the shares. Today's "pop" indicates this is the market consensus view, and, although it eats up part of Sherlund's expected short-term "activist return," it hardly puts a dent in his longer-term, fundamental argument for the stock.

With its huge financial resources and its human capital -- and under new leadership -- Microsoft has a fighting chance of succeeding in its "transformation to a devices and services company," which is the company's objective, according to today's press release. At stake is the future of a trillion-dollar revolution: mobile. But plenty of uncertainty remains and there will be no easy battles. To find out more, we've created a free report called "Who Will Win the War Between the 5 Biggest Tech Stocks?" Inside, you'll find out which companies are set to dominate and give in-the-know investors an edge. To grab a copy of this report, simply click here -- it's free!


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