{"id":1168,"date":"2010-07-23T14:35:58","date_gmt":"2010-07-23T18:35:58","guid":{"rendered":"http:\/\/www.credittrends.com\/blog\/?p=1168"},"modified":"2010-08-13T18:16:58","modified_gmt":"2010-08-13T22:16:58","slug":"superior-management-manifested-in-value-creation-good-bye-mr-ballmer","status":"publish","type":"post","link":"https:\/\/www.credittrends.com\/blog\/2010\/07\/23\/superior-management-manifested-in-value-creation-good-bye-mr-ballmer\/","title":{"rendered":"Superior Management Manifested in Value Creation–Good-bye Mr. Ballmer?"},"content":{"rendered":"

Sometimes it\u2019s better not to hire your friends, admittedly some late advice for former Bear Stearns executives. \u00a0For Bill Gates, it’s\u00a0definitely\u00a0not to late given the superiority in Microsoft’s strength and\u00a0consistency\u00a0in its \u00a0cash flows. However, enough time has gone by to render a verdict on the leadership ability of Steve Ballmer. For Microsoft (MSFT<\/a>), the tables below are telling, as we compare some important metrics to those of Oracle (ORCL<\/a>), its largest and most important competitor.<\/p>\n

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It\u2019s 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.<\/p>\n

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.<\/p>\n

Revealing is the free cash flow as a percentage of cash spent for combined R&D, share buybacks and acquisitions<\/em>. 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\u2019s 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. \u00a0For 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 \u00a0$84.6 billion or a 35.7% yield. This compares with \u00a0just 22.8% for MSFT which has produced $60.7 billion in free cash flow $266 billlion of the three items.<\/p>\n

Cost of capital, using CT Capital\u2019s 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.<\/p>\n

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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.<\/p>\n

The fact that MSFT could not find suitable value-creating opportunities\u00a0is not appealing, as ORCL (and certainly, Warren Buffett) have shown, and is a clear reflection on management. \u00a0Also clear, is the lack of a R&D payoff for MSFT, while ORCL has expanded within their core competencies, effectively utilizing its cash\u00a0 to increase the spread between its ROIC and cost of capital via cash flow based buying of businesses.<\/p>\n

Because of the focus on buybacks, MSFT\u2019s 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, \u00a0in lieu of buybacks, as with ORCL, its multiple would not have diminished to the extent it has\u00a0since\u00a0it would have been\u00a0increasing\u00a0the rate in which it\u00a0generates\u00a0free cash flow. \u00a0In the process it\u2019s cost of capital would have also improved, also\u00a0benefiting\u00a0shareholders.<\/p>\n

We conclude upper management at MSFT has\u00a0not<\/strong> 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\u00a0all its competition-<\/strong> 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\u00a0investment\u00a0in MSFT. \u00a0More 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.<\/p>\n

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