Superior Management Manifested in Value Creation–Good-bye Mr. Ballmer?
It’s no wonder stock in MSFT has been flat the past five years while Oracle is up some 75%. Obviously, buying back stock has not worked any better for MSFT than it has for IBM, which over the past 6 years has repurchased a net (after issuance) $49 billion of its shares.
Oracle, over the past 11 years, has repurchased a net (after issuance) $23.3 billion of its stock while making $34 billion in acquisitions. MSFT has repurchased over $80 billion in stock with just $12 billion in acquisitions. MSFT, for the 9 months to March 2010, repurchased an additional $6.1 billion, not shown on the table.
Revealing is the free cash flow as a percentage of cash spent for combined R&D, share buybacks and acquisitions. This is where these firms best looked for value creation. For this we looked, due to the differing fiscal years, at the past 20 quarters. As one might expect to have seen, MSFT’s large share-repurchase investments have not paid off relative to ORCL’s acquisition-based strategy. We looked at economic return (free cash flow minus a capital charge), and the same result was found—MSFT was far behind. For the total five years combined, ORCL has produced $30.1 billion in free cash flow against net stock purchases plus R&D and acquisitions of $84.6 billion or a 35.7% yield. This compares with just 22.8% for MSFT which has produced $60.7 billion in free cash flow $266 billlion of the three items.
Cost of capital, using CT Capital’s credit model has remained near 7.6% for MSFT, while due to much strong growth in free cash flow, albeit some credit weakening in certain credit metrics, has improved to 7.9% from 8.3% for ORCL. The oft-used expression of there being no better investment than ones own stock has not proved true for MSFT.
Sales for MSFT have risen 284% for the period in the upper table, but for the past five years have risen just 45% compared to 85% for ORCL, the time MSFT was the most active acquirer of its shares.
The fact that MSFT could not find suitable value-creating opportunities is not appealing, as ORCL (and certainly, Warren Buffett) have shown, and is a clear reflection on management. Also clear, is the lack of a R&D payoff for MSFT, while ORCL has expanded within their core competencies, effectively utilizing its cash to increase the spread between its ROIC and cost of capital via cash flow based buying of businesses.
Because of the focus on buybacks, MSFT’s multiple valuation has fallen, migrating to that of the operating company from that entity composed of an operating company and one holding cash. The falling P/E shows reflects the lack of value creation. Had management been successful building its economic return, in lieu of buybacks, as with ORCL, its multiple would not have diminished to the extent it has since it would have been increasing the rate in which it generates free cash flow. In the process it’s cost of capital would have also improved, also benefiting shareholders.
We conclude upper management at MSFT has not been deploying its free cash flow effectively versus its competition, and should be changed for the benefit of its shareholders. Our analysis included over 60 factors relative to all its competition- not just versus Oracle- firms including Symantec, SAP, Checkpoint, Red Hat, and all other firms in its SIC (Standard Industrial Code)- MSFT has shown inferior growth in free cash flow, sales, productivity, and of course its valuation multiple. There has been no improvement to its cost of capital, the return demanded by investors for making an investment in MSFT. More than sufficient time has expired to conclude Mr. Ballmer needs to be replaced with more aggressive and insightful value-creators. He had the tools ( volume and predictability of cash flow) to make it work, but hasn’t taken advantage, while allowing both up-starts and more established firms to pass him by.
Related Articles:
- The Folly of Share Buybacks
- The Folly of Stock Buybacks-Part II
- CFOs Making the Same Mistake Again-Stock Buybacks
Disclosure: No positions
Kenneth S. Hackel, C.F.A.
President
CT Capital LLC
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