Hedge fund ValueAct is reportedly buying more shares of Microsoft Corporation (NASDAQ:MSFT). In April, the firm bought a $1.9 billion stake, and might be using the tech giant’s recent sell off as an opportunity to buy more.
Make no mistake, Microsoft Corporation (NASDAQ:MSFT) is facing its biggest challenge in decades: the decline of Windows. Still, if Microsoft shows a willingness to listen to ValueAct, the company could have a vibrant future.
ValueAct’s bullish thesis
After ValueAct made its stake public, I wondered if investors should follow the firm into the Redmond tech giant. Had anyone done so, they’d be up on their investment, but just barely (about 2.5%).
Although PC sales have been declining for months, Microsoft Corporation (NASDAQ:MSFT)’s stock had remained unscathed. That is, until last week — shares dropped 11% following a terrible quarter. Microsoft’s management admitted that the demand for traditional PCs was declining, while its tablet gambit, Windows RT, has been a total failure.
But ValueAct doesn’t care. In April, the firm’s CEO said that the PC platform as a whole will be irrelevant in three to five years, replaced largely by cloud computing. ValueAct believes Microsoft is poised to dominate the cloud.
Specifically, Microsoft Corporation (NASDAQ:MSFT)’s Azure could become the dominant cloud computing platform. Azure allows other software makers to run their cloud applications on Microsoft’s servers.
Steve Ballmer has a different vision
But Steve Ballmer, Microsoft’s CEO, might not be willing to give up Microsoft Corporation (NASDAQ:MSFT)’s PC business. His recent reorganization of the company aims to, in his words, orient the company around “devices and services.” As I wrote previously, this seems similar to Apple Inc. (NASDAQ:AAPL)’s business model (integrated devices, services, and software).
According to Reuters, ValueAct would like to see Microsoft move away from integrated devices, probably shifting the focus of the company solely to cloud computing.
That would make more sense. Microsoft Corporation (NASDAQ:MSFT) appears to be completely outgunned by both Apple Inc. (NASDAQ:AAPL) and Google Inc (NASDAQ:GOOG) when it comes to mobile computing. While the Windows platform could persist on traditional PCs for years, further attempts by Microsoft to break into mobile computing would amount to throwing good money after bad.
The company just took a $900 million writedown on its Surface RT, while the Windows Phone platform remains far behind iOS and Android in terms of marketshare.
There’s competition in the cloud game
Of course, shifting from Windows to cloud computing is no guaranteed success. For over a decade, Microsoft Corporation (NASDAQ:MSFT) had a virtual operating system monopoly; Windows controlled almost the entire market, with Mac OS and Linux powering a small minority of machines.
But Azure isn’t the only public cloud solution. There’s Amazon.com, Inc. (NASDAQ:AMZN) Web Services, and Google’s Compute Engine. Both are formidable challengers.
Unfortunately, it’s difficult to compare the cloud solutions from a financial standpoint. The companies in question don’t break them out in their earnings reports, leaving second-hand estimates the best methods investors have to evaluate the situation.
Amazon Web Services is king
Nevertheless, by most accounts, Amazon Web Services dominates. In April, Forrester analyst James Staten told Bloomberg that AWS controls over 70% of the market, with Microsoft’s Azure at less than 20%.
Amazon.com, Inc. (NASDAQ:AMZN) accounts for AWS in its “other category” (the main categories being merchandise and media). The category as a whole took in roughly $800 million of revenue during Amazon’s last quarter.
But given that AWS is still a part of a much larger retail operation, interested investors might be better served waiting for a spin off. That’s inevitable, according to Oppenheimer’s Timothy Horan. Still, it remains mere speculation.
Analysts at Lazard Capital believe AWS is enough reason to buy the retailer; they upgraded the stock last week on the hope that AWS would help drive margin expansion.
Google Compute Engine is an emerging threat
As for Google Inc (NASDAQ:GOOG), the company remains an up and comer in the space, but given its extensive experience in cloud technology, it certainly shouldn’t be counted out.
Google’s Compute Engine was only made available to the public in May, so it will be some time before its success can be accurately gauged. However, Google was immediately aggressive in its pricing model, offering subhouring billing when billing by the hour had previously been standard.
The biggest advantage Google Inc (NASDAQ:GOOG) has in the space is its familiarity with cloud infrastructure. Arguably, the company’s entire business is built on the concept of cloud computing, and it has more servers than any other company.
Yet, from a financial standpoint, most seem to be ignoring GCE. It wasn’t discussed during the company’s earnings call last week, and SVP Nikesh Arora payed only token service to the company’s cloud infrastructure initiatives.
And perhaps that’s the source of Microsoft Corporation (NASDAQ:MSFT)’s biggest opportunity — while Google Inc (NASDAQ:GOOG) is focused on advertising, and Amazon.com, Inc. (NASDAQ:AMZN) is shipping goods, Microsoft could be the largest company dedicated chiefly to cloud infrastructure.
Investing in Microsoft
ValueAct’s vision for Microsoft is better than current management’s. Although Amazon and Google Inc (NASDAQ:GOOG) are formidable competitors in the cloud computing space, Microsoft Corporation (NASDAQ:MSFT) at least has a chance with Azure.
If ValueAct can affect real change, there’s reason to be bullish on the long-stagnant Windows-maker.
Yet, that’s assuming a lot. Even if ValueAct dedicated its entire portfolio to Microsoft stock, it would own less than 5% of the company. If Microsoft shrugs off ValueAct’s suggestions, and sticks to its stated goals of being a devices and services company, investors should be wary.
Joe Kurtz has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Inc. (NASDAQ:AMZN) and Google. The Motley Fool owns shares of Amazon.com, Google Inc (NASDAQ:GOOG), and Microsoft Corporation (NASDAQ:MSFT).
The article Can ValueAct Save Microsoft? originally appeared on Fool.com.
Salvatore “Sam” is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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