Unplugged: Microsoft’s secondary status in smartphones

I don’t know many people who own a Windows phone or have bought a Windows tablet lately.

That’s a problem. Despite receiving critical acclaim for its new Windows Phone operating system and its touch-friendly Windows 8 operating system, Microsoft’s efforts to compete with Apple and Google in smartphones and tablet computers – which is where the device market is obviously going – are simply too little, too late. The Microsoft retail store in Palo Alto, Calif., is a tumbleweed-strewn ghost town compared with nearby Apple stores.

After last week’s launch of Samsung’s splashy Galaxy S4, which runs on Google’s Android operating system, Microsoft’s absence from the mobile device discussion is glaring. It’s battling for a distant third – at best – in operating systems behind Apple and Google.

Yet, the determined folks in Redmond, Wash., soldier on.

Microsoft has launched a massive product wave – not to mention a megamarketing blitz — across most of its major businesses well beyond mobile, including Office, Windows Server and Bing. They hope that this will reinvigorate growth; however, these are just upgrades to existing products. They’re not new inventions or new approaches. That’s a problem.

“It buys time, (but) it does not fully address the strategic threat from mobile, which is shifting the center of gravity in computing, stealing the growth from personal computers and potentially eroding Windows Office,” says analyst Bill Whyman of ISI Group, a boutique financial research firm.

Whyman wants to like Microsoft’s stock. He has admired many of the company’s strengths for some time, and he sees more value in many of its businesses than most brokerage analysts on Wall Street. But, unfortunately for Microsoft fans, he doesn’t see a “near-term path to unlock” that value. That’s a problem.

“Microsoft is not likely to pursue a major strategic realignment,” Whyman posits in a research note. The company could afford to buy device makers Nokia, BlackBerry or HTC for about three quarters worth of its operating cash flow, Whyman suggests. The analyst prefers Nokia because of the Finnish mobile giant’s commitment to the Windows Phone operating system. Of course, a handset-maker acquisition could alienate other device manufacturing partners, which is something that Google is struggling with after acquiring Motorola.

Value-style investors love the cash thrown off by the Windows and Office franchises, as well as other divisions that cater to businesses more than consumers. Whyman pegs Microsoft’s 2012 operating income at $31 billion.

But these same investors loathe the risk attached to the company’s efforts to compete in consumer businesses, and they detest the billions lost in Internet services in recent years (Caveat: Most discussion of Microsoft’s consumer efforts should exclude that of the Xbox computer gaming platform, which continues to be successful).

Microsoft shares closed Monday at $28.10, up 5% for the year. That compares with the Dow Jones Industrial Average, which is up 10% this year.

Hedge fund activists and value-style money managers have been pounding the table for years asking for a change in the CEO suite and a potential breakup of the company. But that isn’t likely to happen soon, not as long as co-founder Bill Gates is still chairman and the largest individual shareholder. He’ll remain loyal to his friend and colleague, CEO Steve Ballmer, and when there is time for a change at the top, it will likely come in a very orderly and deliberate manner, people close to the company say.

Microsoft is still a tremendous technology company, but it has matured into an industrial conglomerate that is restrained by its own Windows-centric culture.

“It seems determined to bang-away in individual products across its business,” Whyman notes. The trouble is the company stretches from consumer to enterprise, from data center to device, from services to hardware. That’s a lot of ground to cover. What’s more, Microsoft opted not to bulk up in business software through acquisitions, as did Oracle and IBM, with the exception of strategic Internet-related deals such as Skype and Yammer.

Investors could choose to view Microsoft as more of an enterprise business software stock along the lines of Oracle, as opposed to consumer tech outfits Google, Apple, Facebook and Amazon.com. Nearly 70% of Microsoft’s revenue and roughly 80% of its gross profits come from business customers, Whyman notes. Microsoft’s consensus forward-looking price-earnings ratio is 9 compared with 21 for the enterprise software industry, he says.

Unfortunately, for those who would like to invest in Microsoft as an enterprise pure-play, the company is unlikely to “pursue this enterprise-centric approach” and start spinning off its consumer assets any time soon, Whyman says. This is despite the fact that under the company’s current strategy, “its profit center of gravity will become even more like an enterprise software company,” Whyman says.

That’s a problem.


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