David Einhorn via
In the five years since I first spoke about Microsoft, the most common question I’m asked is what about Ballmer? My initial reaction was to say Ballmer does not care what Wall Street thinks, and maybe that’s a good thing. Wall Street has lots of bad ideas, and people can get rich by ignoring them. It’s more important that he does a good job running the company.
But having now owned Microsoft for half a decade, and having watched the company carefully, I can say that the problem with Ballmer isn’t his attitude toward Wall Street. While the financial results have been good compared to other companies, I believe this reflects an incredibly strong market position that Ballmer inherited rather than his skill as a manager.
Ballmer’s problem is that he is stuck in the past, and is at best a caretaker in an industry demanding constant innovation. He’s allowed competitors to beat Microsoft in huge areas including search, mobile communication software, tablet computing, and social networking. But even worse, his response to these failures has been to pour tremendous resources into efforts to either buy or develop his way out of these holes.
The best example of this behavior was his 2008 attempt to throw several years of Microsoft profits into premium priced purchases deteriorating Yahoo! business. Here Microsoft was only saved by Yahoo!’s then management, which proved by to be even crazier by rebuffing the offer. But the risk that on any given day we could wake up with the announcement of another bad and very expensive acquisition has an ongoing dampening impact on Microsoft’s PE ratio.
For another example, let’s consider this quote from a 2006 interview with Fortune.
Q: “Do you have an iPad?”
A: “No I do not. Nor do my children. I’ve got my kids brainwashed. You don’t use Google and you don’t use an iPod.“
Or this quote from a 2007 interview in USA Today:
“People get passionate when Apple comes out with something new. The iPhone of course, the iPad, the iPod. Is that something you’d like people to feel about Microsoft?”
Ballmer says, “It’s sort of a funny question. Would I trade 96% of the market for 4% of the market?” And he laughs to himself. “I want to have products that appeal to everybody. There’s no chance that the iPhone is going to get any significant market share, no chance. It’s a $500 subsidized item. They make a lot of money. But if you actually take a look, the 1.3B that get sold, I prefer to have software in 60% or 70% or 80% of them. I’d rather have that than the 2-3%, which is what Apple might get.”
[…]
Every year Microsoft invests $9B in shareholder money and R&D. Much of it is wasted on product that will never see the daylight, or worse, is spent on products like the Kin, which was pulled from the market after just 48 days.
But a good chunk of that goes to developing future generations of Windows and Office. Perhaps if Ballmer eased up on brainwashing and let his kids play with the most popular devices, he would see the opportunity in making available a version of Office for the iPad and the Android devices.
The search business is another sinkhole. On pace to generate $2.5B or more in operating losses this fiscal year, the sixth year of operating losses. Even for Microsoft, these losses at 25% per share, matter, especially when the losses are growing over time. (I’m going to use Bill Ackman’s 2.5 minutes.)
Microsoft’s dogged determination to be successful in this field by investing as much money as necessary for as long as necessary is a result of having the high margins of Windows and Office to subsidize the losses. At the very least it’s time for Microsoft to consider strategic alternatives for its search business.
One possibility would be to strengthen the existing strategic relationship it has with Facebook, where my cousin Sheryl has worked as the COO since 2008. Since search is a scale business, and scale comes from traffic, currently Microsoft spends heavily to drive users to Bing. Facebook could help Bing achieve scale and reduce Microsoft’s need to pay for traffic.
Likewise, paid search at scale is one of the most proven high margin businesses on the internet. Microsoft could help Facebook with one of the biggest challenges, namely monetizing its traffic without reducing the user’s experience. It’s obvious that Microsoft needs traffic and Facebook needs search. As the cost to create a new search engine of its own is prohibitive, the revenues paid search through Bing would be capitalized in a much higher multiple on Facebook’s income statement than on Microsoft’s.
With the JV, or perhaps even an outright sale, Microsoft can contribute Bing in exchange for a sizeable minority interest in Facebook. This would be a win-win for both companies and their customers.
But for my final thoughts on Microsoft’s future, I’d like to revisit one last Ballmer interview from Business Week in 2005. In it he says
Great companies and the way they work start with great leaders. You have to say, do you have great leaders? All companies of any size have to continue to push to make sure they get the right leaders, the right team, the right people to be fast-acting and fast-moving in the marketplace. We’ve got great leaders, and we continue to add and attract and promote great new leaders. And he later added, we’ve bought on fantastic new talent, people like Ray Ozzie, Gary Flake, and Li Gong.
Well Ray Ozzie, Gary Flake and Li Gong have all left Microsoft, along with Robbie Bach, and J Allard, who were largely responsible for the success of X-Box. Four other division presidents have left Microsoft since 2008 as well as former CFO Chris Liddell. Good grief!
Perhaps the question is not do you have great leaders, but rather do you have a great leader?
Ballmer starting to look like Newt Gingrinch: all of his staff is ditching him. Why does the board let him stay on? Is Gates protecting him?
Search engines have long been judges of what is important; now they are also arbiters of the truth.
