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Re: Interest in MSFT?

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By RedneckRoleModel
October 6, 2005

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I have looked at MSFT and chosen not to invest for a variety of reasons. However, there are, to my mind, only two that matter.

1.) End of the competitive advantage period: I believe, though the numbers don't show it yet, that MSFT is entering the end of their competitive advantage period. Other people on this thread have already discussed the primary reasons I believe this.

First, the upgrade cycle has lengthened tremendously from what it was ten years ago. While there is a large base of consumers still using '98 and 2000 versions of Office and Windows, the PC upgrade cycle has largely replaced similar machines in most corporate settings. The cycle is harder to see now than it was ten years ago, but there was a surge in buying in 1999 (preparation for Y2K), and most of those machines were replaced starting in late 2003 and through mid 2005. Running XP, and with speeds of 1.5 GHZ or more, those machines will likely last through the decade, since there are no mass market applications that tax these kinds of computing resources. How many corporations do you know that upgrade the operating system or productivity software on an old machine, rather than just waiting a couple of years to buy new PCs with new software?

Secondly, the service-oriented architecture movement that was described so well by rhohne1 is a real threat. The knock against web based software services is that they had a look and feel similar to traditional web pages--that is, they required constant refreshes to access new data or to save old data. That has now changed, through a variety of programming methods called rich Internet applications (RIA). Some people call them AJAX, some call these methods other names I haven't even heard of, but the basic idea is that they blur the distinction between browser and web server, allowing for the exchange of information without refreshing the page. This sounds prosaic and overly geekish, but you can see what a big deal it is if you try Yahoo Mail's new interface (www.yahoo.com). This is not something that will make people give up Word, Excel and PowerPoint tomorrow, but these things always start small and appear insignificant at first.

2.) Price: Sure, 14X EV/FCF is a lower multiple than MSFT has ever traded at before, but they're only growing at about 10% right now. I can buy 10% growers a lot cheaper than that in today's marketplace. Not one company I buy will have the competitive strength of MSFT, but I'm OK with that at under 10X FCF. Ultimately, my lack of enthusiasm about MSFT is probably based on the fact that I'm looking for big, obvious mis-pricings, and I don't see anything obviously too cheap about MSFT here. Also, I have a bias against ultra large cap stocks--I almost never buy them, except in storm-of-the-century markets like 2002.

Could it go up 25% with some change in sentiment? Sure! But I believe that any investment in MSFT today is contingent upon some expectation of a higher multiple, and given my concerns about their deteriorating competitive position, I don't believe a higher multiple is warranted. I think MSFT is trading with +- 15% of its intrinsic value today.

Best,
Redneck


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