Whitney Tilson was extremely bullish about Microsoft in his 2010 yearend letter to investors. He expected Microsoft to reach $35. Here is what he said about Microsoft back then:
Microsoft reported spectacular earnings in late October, handily beating analysts’ estimates, yet the stock has barely moved so we’d added to our position.
Adjusting for the deferral of Windows 7 revenues last year, Microsoft reported revenue, EPS, bookings, and operating cash flow growth of 13%, 19%, 24%, and 34%, respectively. The company’s results were strong across the board, riding a wave driven by its three main profit drivers, Windows, Office, and Server & Tools.
Capital allocation was excellent, as Microsoft has (so far anyway) avoided doing what so many other large, cash-rich companies are doing, making a big, overpriced acquisition, and has instead wisely ramped up returning cash to shareholders: $5.5 billion last quarter via $1.1 billion of dividends (the stock currently yields 2.3%) plus $4.4 billion of share repurchases (up 3x year-over-year, leading to the diluted share count falling 3.2%). At this rate, the company will retire nearly 8% of its outstanding shares in the next year.
The stock closed the year at $27.91 and the company has $3.85 of net cash ($4.91 if one includes “Equity and other investments”), so the stock, net of cash, is at $24.06. Trailing earnings are $2.32/share, so that’s a P/E multiple of 10.4x. That’s insanely low for a company with Microsoft’s characteristics: dominant and stable market shares across various products, 81% gross margins, 33% net margins, an infinite return on capital, prodigious cash flows, and one of the strongest balance sheets in the world.
The consensus view is that Microsoft is an incompetent, lumbering dinosaur, declining rapidly toward the dustbin of history. Newspapers, check printers and paging companies, look out! The problem with this view is that there is no evidence for it. Despite endless predictions over the past decade of how Apple or Linux or Google Apps are going to erode Microsoft’s dominance in its key product categories, the company’s market shares are stable or rising. Revenues and profits, rather than falling, are rising sharply.
Yet analysts persist in ignoring the overwhelming evidence of Microsoft’s powerful new product cycle and are projecting flat revenues and EPS down 8.1% for the current quarter (ending December 2010), and flat earnings for the remaining three quarters of the 2011 fiscal year. In light of such low expectations, we believe Microsoft will continue to handily beat estimates over the next year, with earnings growth in the mid-teens. This, combined with likely multiple expansion, should result in the stock appreciating to at least the mid-$30s range with a year.
Microsoft lost 8.4% in 2010. It lost another 8% so far in 2011. It seems like Tilson is still extremely bullish about Microsoft. Recently Tilson recommended “big-cap blue chip companies that are trading at moderate prices”. “(Apple is) a fabulous business, but I’m simply pointing out that you can own a better business, albeit one that is not growing as quickly — but still growing nicely — for half the price in terms of price-to-earnings multiple,” Tilson said to Reuters.
Tilson’s strategy hasn’t helped his returns much this year. He is trailing the S&P 500 index by 9 percentage points this year. T2 Partners lost 3.1% during the first quarter, vs. up 5.9% for the S&P 500.
