Is Microsoft (Nasdaq: MSFT) worth more as an organ donor than alive in one piece?
A shareholder raised the idea during yesterday's annual meeting: "Is it time to consider breaking this company up?"
CEO Steve Ballmer naturally shot down the notion. Nobody likes to be told that the sum of a company's parts is worth more than its whole. It implies that executives aren't doing their job, and it suggests that synergies not only don't exist, but also may actually be detrimental.
However, Ballmer has every right to hear that question. Even adjusted for dividends, Microsoft's stock has essentially gone nowhere over the past decade. Apple's (Nasdaq: AAPL) been on a tear in that time, and no one is asking Steve Jobs about a legal separation between Macs and iOS gadgetry.
Ballmer's decision to begin diversifying by selling off some of his Microsoft shares earlier this month -- coupled with recent analyst downgrades -- doesn't paint a very pretty picture for the world's largest software company.
Between last year's successful debut of Windows 7 and this year's rollout of Office 2010, Microsoft has shot the two biggest arrows in its quiver. The end result? Microsoft is one of the few tech giants to be trading lower this year.
Splitting up Microsoft isn't a ridiculous notion. If the stock's price continues to waffle about in the twenties for much longer, it won't be long before shareholders storm Redmond looking for blood.
Picking up the pieces
How would one go about breaking up Microsoft to maximize its value?
The easiest fix would be to spin off its video game and online businesses, keeping Microsoft around as a pure maker of operating system, productivity, and server software. After all, those areas command the thickest margins.
The two spin-offs would be a lot smaller. Microsoft's Xbox has been the hot console in recent months, but the video-game industry has been trending lower since early last year. Over in cyberspace, Bing is gaining mindshare -- if not necessarily market share -- but remains the one subsidiary that continues to lose money for Microsoft.
Carving out Bing and Xbox would improve margins at the software heart of Microsoft. The company would have the flexibility to jack up its yield, attracting income investors who may not be as concerned about the stagnancy -- and possible decline -- in Microsoft's software business as open-source solutions and mobile devices continue to grow in popularity.
Playing games with the appendages
Console prices have plummeted over the years, and it's widely believed that Microsoft subsidizes its Xbox 360 systems in exchange for chunky software royalties down the line. Developers pay Microsoft for every copy of an Xbox game that they crank out.
One of the industry's biggest problems is that folks appear to be buying fewer games, largely because individual titles now have longer shelf lives thanks to online action.
Microsoft is sitting pretty on that end, though. Xbox Live has 25 million gamers spending an average of 40 hours a month on its platform, largely in the form of premium Gold subscribers. How many television networks would love to have that kind of sticky audience?
Sony (NYSE: SNE) is in a funk, and Nintendo (OTC BB: NTDOY.PK) has problems, but they're not contagious. Sony's woes go beyond its PlayStation struggles, and Nintendo is simply suffering as its rivals catch up. The prospects of Xbox Live's marketplace in a future moving to digital distribution, and its hold on a typically elusive target audience, are huge. Xbox alone would command a healthy premium.
Bing, on the other hand, would be harder to quantify. Outside of Google, the sector holds few success stories. Yahoo!'s (Nasdaq: YHOO) Asian investments command a greater value than its actual portal, and IAC's (Nasdaq: IACI) Ask.com all but threw in the towel.
However, Bing is also making waves. Microsoft hoodwinked Yahoo! into outsourcing its search functionality to Bing, and the company's also been making waves in Asia, teaming up with Chinese darlings Alibaba and SINA (Nasdaq: SINA) on online initiatives. Despite the red ink, and the mere 8% revenue growth in its latest quarter, Bing, too,would likely trade at a market premium if spun off.
Monsters under Ballmer's bed
What is Microsoft afraid of here? Spinning off its entertainment and online divisions -- a combination that posted a $200 million operating loss on just $2.3 billion in segment revenue last quarter -- would help beef up the margins and overall profit behind the $13.9 billion in revenue that Microsoft rang up elsewhere.
If Xbox and Bing wind up commanding market premiums, why can't the software-heavy Microsoft they leave behind -- generator of $7.3 billion in operating profits this past quarter -- be worth more on its own, too?
From where I stand, the sum of Microsoft's parts is worth more than shares of MSFT are today.
I'm sorry, Ballmer, but it's true. This question deserves more than a routine dismissal before your frustrated investors.
