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February 17, 2008

Joe Rosenberg: A Pan to Microsoft/Yahoo

A fairly savage pan in the weekend Barron's of the Microsoft/Yahoo deal courtesy of Loew's Joe Rosenberg:

Joe, you see opportunity in the stock market. Where do you want to begin?

Let's take the headline of the moment, Microsoft [ticker: MSFT]. When I was last interviewed in Barron's, I was bullish on Microsoft, but I also was very critical of CEO Steve Ballmer's leadership of the company. My view on both Microsoft and Ballmer hasn't changed. It's a bad reflection on Ballmer that he's willing to pay a ridiculous price for Yahoo! [YHOO]. Microsoft is not going to earn anything like a reasonable rate of return on its investment in Yahoo! It just doesn't make sense. It will be even more ridiculous if Microsoft increases its bid. The market is telling you what it thinks. Microsoft's stock is down by four points, to 28, since it announced the bid. That's almost $40 billion of value destruction, which is nearly as much as the value of Microsoft's bid for Yahoo!. The best thing of all would be if Microsoft drops its bid.

People say it's a strategic necessity for Microsoft to buy Yahoo!.

I don't buy that. Yahoo! would significantly dilute Microsoft's returns. Can you think of a major tech deal that ever worked out? The people who are cheering on the deal, saying that Microsoft should increase its bid, are investors like Bill Miller who are stuck with big positions in Yahoo! [Miller runs the Legg Mason Value Trust.]

Ballmer is a great operating man, but he lacks financial acumen. He ought to be thinking more of Microsoft employees, who own a lot of Microsoft stock and have nothing to show for it in many years. If the stock doesn't start doing better, Microsoft will lose good people.

Even though you believe Ballmer is making a mistake with Yahoo!, do you still like Microsoft stock?

Microsoft is a buy, either way. It's a better buy without Yahoo!. Microsoft is going to earn close to $2 a share in its fiscal year ending in June. So it's trading for just 14 times earnings. If you go out to 2012, I estimate earnings at more than $4 a share. That's higher than the Street, which is around $3.60. Even on the $3.60 estimate, Microsoft is very attractive, trading for eight times that estimate.

Microsoft's earnings equal free cash flow. It's a phenomenal money machine with loads of cash. Microsoft ought to take advantage of its depressed stock price and announce a Dutch-auction tender for its stock. Microsoft is actually cheaper than it was two years ago.

What's going right at Microsoft? Many investors think that it's past its prime.

Investors don't appreciate the growth in Microsoft's earnings coming from the developing world. Ballmer has talked about this. Piracy in the developing world is going away. Part of it has to do with the way the code was written in the new Vista operating system and part of it is that, as countries become more developed, they can't allow software to be pirated and sold on the street.

Where can the stock go?

If by some miracle, the Yahoo! deal falls through and Microsoft goes it alone and it can achieve my estimate, which is north of $4 in 2012, the stock could be trading at 80 in a few years. Even if Microsoft buys Yahoo!, the stock could be a lot higher.

[Emphasis mine]

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