Microsoft (NASDAQ:MSFT) stock gained around 4% yesterday — briefly topping $31 before closing just under — to solidify a 7% march since last Thursday’s earnings report.
The two-part rally started with Thursday’s earnings and was followed by news on Monday that activist hedge fund ValueAct Capital Management was holding $1.9 billion in MSFT stock.
The jump was a nice change for the company, too; it’s been a while since shares have been on anything that could be described as a tear. MSFT took off on a 30% run at the end of 2011 — jumping past the $32-mark — but then stumbled and was hovering around $26 for most of 2012.
Of course, the recent gains raise the question of whether or not the run will last.
The way I see it, there are three likely outcomes, depending on how you interpret the information and how things play out:
- After a short time above $30, Microsoft drops back into that $26-$27 rut.
- MSFT stays above $30 (possibly climbing higher) and stays there for a good chunk of 2013 before drifting down to the $26-$27 range once again.
- This is the start of a long-term resurgence for Microsoft, with a growing market valuation reflecting its increasingly important role in a post-PC world.
The first outcome seems likely when considering the ValueAct disclosure, while the second seems possible considering its earnings.
In a quarter where PC sales plummeted, Microsoft managed to beat Wall Street’s earnings estimates, growing its earnings 19% while offering shareholders a 3.2% dividend. That could be enough to keep MSFT aloft until the next quarter … but whether it remains at that level would be a function of whether it continues to outperform earnings expectations, or takes another hit from that struggling PC market.
Of course, that’s if it lasts that long in the first place. See, one of the most frequent criticisms against Microsoft has been that CEO Steve Ballmer is a relic who hasn’t been able to keep his company competitive as the PC has declined in relevance. Another hedge fund (Greenlight Capital) with a stake in Microsoft campaigned to push Ballmer out in 2011, but that (obviously) didn’t work.
With news of this disclosure, there was immediate speculation that ValueAct might try the same thing. However, despite the near $2 billion stake and being in the top 15 of Microsoft investors, Bill Gates still holds around 5% of the company and he’s been firmly behind Ballmer.
And according to Reuters, ValueAct CEO Jeff Ubben said that his company would not be publicly pushing to change Microsoft’s strategy, with his only comment in this area being that Microsoft’s Office suite should been available for other platforms such as Apple’s iPad. That’s a sentiment that’s been widely echoed for years, amid reports that Microsoft is working on iOS and Android versions of Office, but that they have been delayed until 2014.
With that in mind, it’s quite possible that we see outcome No. 1 as investors realize that ValueAct isn’t going to try to drastically shake things up and push out Ballmer. At this point, the excitement will wear off and Microsoft will settle back into its comfort zone.
Instead, the key thing to take out of the ValueAct comes from a statement on the company’s website:
“ValueAct Capital concentrates on acquiring significant ownership stakes in a limited number of companies that it believes are fundamentally undervalued. The investment team seeks to identify companies that are out of favor, or may be undergoing significant transition.”
In other words, the company is making a big bet that Microsoft is currently undervalued and due for a resurgence — scenario No. 3. Of course, this possibility is based on a lot of things going right for Microsoft.
Despite a long period of underperformance while other tech giants like Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) have been the story, Microsoft has been working on reinventing itself for that Post-PC world and some of those initiatives have the potential to take off.
Surface tablets have seen middling sales at best, but there are reports Microsoft is prepping 7-inch versions that would make its tablet lineup more competitive given consumer preference for the cheaper and more portable form factor. Windows Phone market share is still small, but its climbing after the release of Windows Phone 8.
Its Azure cloud computing service is performing well and in growth mode with predictions it could hit $20 billion in yearly revenue by the end of the decade. And if the company is able to bring Office to mobile platforms, analysts think that could be worth $2.5 billion in revenue yearly for iOS alone.
Even Windows 8, which has not been the hit Microsoft hoped, could see a sales surge based on reports the company is bringing back the “Start” button to Windows 8 – a concession that is expected to help convince Windows XP and Windows 7 holdouts to upgrade.
Apple, the company that’s most exemplified the difference between a PC-centric rut and a post-PC business success, is currently stumbling — a situation which could shine a more positive light on Microsoft.
Amid this backdrop, Microsoft is getting favorable press for its strategies and it does look as though some of them could be paying off. So while scenarios No. 1 and No. 2 seem like the most likely outcome for Microsoft — based on its performance the past decade and based on the realities of the rally — No. 3 is not out of the question.
As Wired put it a few days ago: “Microsoft is still a lumbering giant. But for the first time in years, it’s lumbering in the right direction.”
As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.