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As a value investor I used to spend a great deal of time in Microsoft hell – on one hand there was the company with enormous cash flows, an incredible return on capital, a huge moat, a cash-rich balance sheet, and trading at single-digit multiples (if you adjust for cash). But on the other hand it threw away cash away for multi-billion-dollar acquisitions, followed up by inevitable write-offs. Its founder and chairman was not interested in running the company, so he delegated to his best friend, who has been wrong at every single technological inflection point, and quite frankly not a very good leader. Every few years the company airbrushes its old products (think of Office), calls it an upgrade, and goes on charging subscription fees; but new products quite frankly … suck. Microsoft’s competitors are getting better, and while a strong balance sheet helps in bad times, it is not a competitive advantage against competitors that have even more cash.
I was stuck in the middle– Microsoft was too cheap, but if it kept doing what it was doing it would become a declining annuity, at best. Finally last year, after I previewed Windows 8, we sold the stock and bought Oracle – it has all the aforementioned positive Microsoft’s qualities (competitive advantage, recurrence of revenues, balance sheet, etc…) with one significant bonus: it is run by Larry Ellison.
Larry owns a third of the company. He is the third-richest person in the world. Normally this would not matter, but Larry is extremely competitive and he wants to be the richest person in the world. The only way for him to get there is by increasing the value of Oracle. With Larry running the company I don’t have to worry about dumb acquisitions, dilutive stock options, or share repurchases that will destroy value. Oracle is facing competition, but Larry is very aware of it and has been fighting different competitors for decades. Larry is on every earnings conference call. (By the way, if you have never listened in on Oracle’s conference calls, I highly recommend it – very entertaining). Finally, Oracle’s valuation is similar to Microsoft’s.
Back to Microsoft. By the time I finished writing the following article (read article here) I had achieved this clarity: unless a new outside CEO is brough in to fix the Microsoft culture, Microsoft as a stock is dead to me.
One more thing: Samsung introduced their watch on Wednesday. I think that is great news for Apple shareholders. The watch looks like it came straight out a 1990s Timex catalog; they have set the bar for Apple’s watch very low.
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.
Investment Management Associates Inc. is a value investing firm based in Denver, Colorado. Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.