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Tilson's Valuation July 20, 2010: Sell between $35 and $40 within 12-18 months
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//At less than 12 times projected profits of $2.76 a share in the company's fiscal year ending in June 2014, Microsoft's shares look appealing. The effective price/earnings is even lower since Microsoft is sitting on net cash and investments of $72 billion, or more than $8 a share. The stock yields 2.9%.
Microsoft is expected to lift its dividend in mid-September. It also will hold its annual financial analyst meeting on Sept. 19. Investors will be watching to see whether the dividend gets boosted more than the expected 15%, which would be viewed favorably, and whether the company is willing to commit to a more ambitious share-repurchase program than the modest plan now in place.//
SATURDAY, SEPTEMBER 7, 2013 | By ANDREW BARY
It's the Shareholders, Stupid
Microsoft's reputation for overpaying for big acquisitions seems sadly intact with its $7 billion Nokia deal. How a disciplined financial leader could create enormous value for shareholders.
Just when it looked as if Microsoft might be on the verge of focusing more on shareholder returns than on dubious strategic initiatives came the news last week that the company is paying $7 billion for Nokia's ailing mobile-phone business.
That deal deflated Microsoft shares (ticker: MSFT), which had appreciated in late August on the surprise announcement that Steve Ballmer, the longtime CEO whose many missteps and high-handed approach with investors made him unpopular on Wall Street, would be stepping down ("The Long Goodbye," Aug. 26, 2013).
Microsoft shares fell 7% last week, to $31.15, below their recent high of $35 reached after the Ballmer news.
CEO Steve Ballmer's acquisition of Nokia's mobile-phone business will saddle his successor with $19 billion in new costs and 32,000 new employees.
Investors shouldn't despair because beneficial change appears to be coming at Microsoft, albeit more slowly than many shareholders would like. An activist investor, ValueAct Capital, was recently offered a board seat, and it's a good bet that the firm will push for a larger return of capital to shareholders through a much larger share- repurchase program and a higher dividend.
At less than 12 times projected profits of $2.76 a share in the company's fiscal year ending in June 2014, Microsoft's shares look appealing. The effective price/earnings is even lower since Microsoft is sitting on net cash and investments of $72 billion, or more than $8 a share. The stock yields 2.9%.
Microsoft is expected to lift its dividend in mid-September. It also will hold its annual financial analyst meeting on Sept. 19. Investors will be watching to see whether the dividend gets boosted more than the expected 15%, which would be viewed favorably, and whether the company is willing to commit to a more ambitious share-repurchase program than the modest plan now in place.
"Investors have wanted Microsoft to reduce its exposure to a declining consumer space and focus on its stronger enterprise business and pay out more cash in the form of share repurchase and dividends. Management succession was thought to help in this regard, but the Nokia deal doubles down on the cost structure for the consumer business and makes it more difficult to reduce costs," wrote Nomura analyst Rick Sherlund in a client note.
Sherlund told Barron's that "not even a mother could love" the Nokia deal, which gives Microsoft ownership of its cellphone partner; Nokia's Lumia smartphones are powered by Microsoft's Windows Phone operating system. Without Nokia, the Windows Phone OS likely would have gained little traction. As it is, Windows has just 4% of the smartphone market, which is dominated by Apple and Google's Android platform.
Nokia's mobile-phone business is losing money. Microsoft is projecting the deal will dilute earnings in its current fiscal year by eight cents, or almost $700 million, after taxes. Microsoft hopes the business can break even in fiscal 2015, but that assumes market-share gains and cost-cutting initiatives that may be tough to achieve.
THE NOKIA DEAL ALSO raises the prospect that Stephen Elop, the Nokia CEO who previously ran Microsoft's successful business division, could succeed Ballmer. Elop, who will rejoin the software giant, isn't an investor favorite, due in part to Nokia's weak financial performance. One potential CEO candidate with a strong operational background who likely would play well with investors is Sanjay Jha, the former CEO of Motorola Mobility, which was sold to Google in 2012. Jha was dealt a tough hand given Motorola's wireless-phone woes, but he played it well and orchestrated the Google sale at a nice price.
What bothers many investors is that Microsoft continues to make strategically and financially questionable acquisitions when it could be aggressively buying back its own shares. "The most attractive thing Microsoft can buy is its own shares," says an investor.
The company paid $8.6 billion for Skype in 2011, and it's unclear what kind of returns that has produced. Another large deal, the $6 billion purchase in 2007 of aQuantive, an Internet marketing and advertising company, was a bust, with Microsoft writing down the purchase price in 2012. An investor likens the Microsoft acquisition strategy to "science experiments."
Microsoft's share buyback has been modest at $5 billion in each of the past two fiscal years, relative to its earnings power of more than $20 billion and its enormous cash reserves of $77 billion; it has just $16 billion of debt. Microsoft also has $11 billion of equity and other investments. The buybacks have made only a small dent in Microsoft's share count, which stood at 8.4 billion at the end of June.
Microsoft has returned about 60% of its earnings to shareholders in the past two years via dividends and buybacks.
ONE MODEL FOR MICROSOFT is IBM, which been able to generate nice shareholder returns from a low-growth business due in part to heavy share buybacks. IBM bought back $12 billion of stock in 2012—more than double that of Microsoft—with a smaller earnings base. Over the past three years, IBM (IBM) has returned about 100% of its profits to investors via dividends and buybacks.
It has been tough for investors to influence Microsoft management because of the company's sheer size and the difficulty in amassing a meaningful stake. That is changing with ValueAct's emergence in the spring as a Microsoft holder. ValueAct holds less than a 1% stake, but that investment understates its influence because it appears to have the support of some large Microsoft holders.
ValueAct and its chief investment officer, Jeff Ubben, haven't unveiled a Microsoft playbook—the firm prefers to operate quietly—but Sherlund thinks it may involve a push for Microsoft to borrow heavily against its overseas cash hoard to fund a large share-buyback program and a willingness to pay U.S. taxes on foreign-sourced income in order to pay a higher dividend.
One reason investors aren't crazy about the Nokia deal is that it adds 32,000 employees and a roughly $19 billion annualized cost base to Microsoft, which already has nearly 100,000 employees and about $50 billion of annual expenses. The added staff and expenses will make it tougher for Ballmer's successor to cut expenses.
Microsoft's independent directors may be receptive to the ValueAct agenda, Sherlund says. A key director among the current nine could be Seagate Technology CEO Steve Luczo, who joined the board last year.
The Bottom Line
Microsoft could be attractive if it follows the lead of outside director Steve Luczo, CEO of Seagate, and aggressively returns cash to shareholders.
Seagate (STX), one of the two leading makers of disk drives along with Western Digital (WDC), is similar to Microsoft in that it's in a relatively mature business threatened by declining PC sales and potential new storage technologies. Luczo's financial strategy has been to aggressively return cash to shareholders through its dividend, now nearly 4%, and a large share-repurchase program. Seagate shares have responded, tripling in the past three years.
There's an enormous amount of value that could be realized in Microsoft despite its well-documented challenges. What the company needs is a leader who will make disciplined financial decisions and deliver for shareholders. One of its own directors has even shown the way
Bottom Line: Fair value for Nokia's stock is about $7 per share, analysts say, but that seems conservative.
Barron's | International Trader - Europe| SATURDAY, SEPTEMBER 7, 2013 | By JONATHAN BUCK
Sans Phones, Nokia Could Be a Winner Again
The company has a chance to prosper as a wireless-equipment maker.
Nokia's shares jumped last week following the sale of the Finnish company's handset business to Microsoft —and they could go higher still.
How much higher will depend on the strategic direction Nokia (ticker: NOK) decides to take when the deal with Microsoft (MSFT) is completed. It also depends on what Nokia decides to do with the 7.8 billion euros ($10.23 billion), from the deal—along with the cash it already has on its balance sheet—which will swell its coffers. The company will probably use some of that cash for acquisitions, but it has indicated that "excess capital" will be returned to shareholders.
Investors can expect a special dividend or a return to regular dividends, but they shouldn't get too excited: Nokia has served up more than its fair share of disappointment in recent years. However, if Nokia sets aside about €5 billion for acquisitions and investments, it could return €2.5 billion to shareholders. Based on the number of shares outstanding, it would be equivalent to a yield approaching 15%.
At midday Friday, Nokia's American depository receipts were trading at $5.35 in New York, up about 37% on the week. It's a juicy return for short-term investors, but it's scant consolation for anyone who has held the stock over the longer term. The ADRs fetched more than $50 in 2000.
JUST A FEW YEARS AGO, NOKIA held a dominant share in the global market for handsets, but technological missteps have turned it into an also-ran behind nimbler smartphone makers Apple (AAPL) and Samsung (005930.Korea), whose devices offer slick operating systems with a variety of cool apps. Nokia hitched its wagon to Microsoft to promote a Windows-based operating system, but this has been slow to catch on. Microsoft will soon have sole charge of the hardware, as well as the software.
Nokia shareholders should be happy to let Microsoft go it alone. Nokia's handset business has been burning through hundreds of millions of euros in free cash flow every quarter for the past 18 months. History shows it is hard to play catch-up in the technology sphere—a message not lost on BlackBerry (BBRY). Nokia has reinvented itself before; it can do so again.
With the completion last month of the purchase of Siemens' (SI) stake in their joint venture Nokia Siemens Networks, Nokia is becoming primarily a provider of wireless equipment, competing against L.M. Ericsson Telefon (ERIC) and China's Huawei Technologies. It also will retain its mapping and location-services business, and technology-development and licensing operations, which include its portfolio of patents.
Fair value for Nokia's stock is about $7 per share, analysts say, but that seems conservative. The bulk of Nokia's worth is made up of the anticipated cash pile and the value of the Nokia Solutions & Networks (NSN), as it is now known. Société Générale ascribes zero value to the mapping business. Even though its software is available in four of five cars with pre-installed mapping devices, it generated profit of only €3 million in the first half of 2013.
The patent portfolio is equally difficult to put a price on. Nokia has an estimated 20,000 granted or pending patents. Nortel Networks (NRTLQ) sold about 6,000 patents in 2011 for $4.50 billion. That suggests Nokia's patents could be worth as much as three times that amount. Nokia currently earns about €500 million a year from licensing its patents to rival handset makers.
NOKIA'S SALES ARE ESTIMATED at about €14 billion in 2015, the first full year of operation without the handset business. That's down from previous estimates of more than €26 billion. In spite of that, Credit Suisse reduced its profit forecast only 18% because the network-gear business is more profitable. Sales were over €30 billion in 2012, and Nokia lost 84 European cents a share.
Nokia Solutions & Networks is a key supplier to carriers in Europe and developed markets in Asia, including Japan and South Korea, but it lacks scale in the U.S. and China. Nokia could remedy this by spending some of its war chest on Alcatel-Lucent's (ALU) wireless business, which looks like a good fit for NSN. Alcatel-Lucent is a major supplier to the U.S.'s three largest carriers, Verizon Wireless, AT&T (T), and Sprint (S), as well as to China Mobile.
The timing could be perfect for Nokia. Alcatel-Lucent this summer announced a strategic overhaul that will include the sale of some operations. On Aug. 28, it appointed a former investment banker as its new chief financial officer, raising the possibility of a breakup. Investors expect Nokia to take a closer look: Alcatel-Lucent's ADRs climbed about 20% last week, in anticipation of a deal with Nokia.
Barron's Cover | SATURDAY, SEPTEMBER 7, 2013 |By LESLIE P. NORTON
Lenovo Attacks
Lenovo came out of nowhere to become the global leader in PCs. Now it's got its sights set on Samsung and Apple in smartphones and tablets.
Yang Yuanqing has succeeded where many others have tried and failed. In just eight years, the chairman and CEO of Beijing-based Lenovo Group has transformed the company from a little-known maker of personal computers into the No. 1 global PC brand, displacing a half-dozen would-be challengers along the way, including Acer, Asustek, Toshiba, and Sony . And even in a now-fading $200 billion PC industry, Lenovo (ticker: LNVGY) continues to gain market share at the expense of former leaders Hewlett-Packard (HPQ) and Dell (DELL).
At the same time, while Dell, HP, and others have struggled to gain purchase in smartphones and tablets, Lenovo has pushed itself into the No. 2 spot in China in smartphones, after Samsung Electronics (005930.S.Korea) and ahead of Apple (AAPL). Now Yang is out to conquer the world — again.
As of June, according to researcher IDC, Lenovo had a 7% share of the global "smart interconnected device market" — smartphones, tablets, and PCs. That's well behind Samsung's 24% and Apple's 14%, but it's almost twice that of the next largest player, HP, with 3.6%. "They've clearly broken away from the pack," says Bob O'Donnell of IDC.
Even as PC volume is expected to shrink to 315.4 million units this year, 9.7% below 2012's total, analysts see Lenovo's earnings rising 19%, to $758 million, or $1.40 per American depository receipt, on $37.3 billion in revenue, as sales shift to higher-margin products. For the fiscal year ending March 2015, analysts forecast earnings growth of 17%.
Lenovo is best-known in the U.S. for its ThinkPad laptops, the brand that it bought from IBM (IBM) for $1.75 billion in 2005.
Two years ago, Lenovo introduced its first tablets, under the ThinkPad name for enterprise customers and IdeaPad for consumers. Next year, it's expected to launch its first U.S. smartphone, further broadening its reach here.
But emerging markets are Lenovo's main source of growth. "In both tablets and smartphones, the market is shifting from the premium space to the mainstream and entry-level space, and from mature markets to emerging markets," Yang told Barron's in a recent interview. "In mature markets, the refreshment cycle becomes shorter and faster. This trend favors Lenovo because we are stronger in mainstream, we are stronger in emerging markets, and our development cycle is much shorter than our competition's," a benefit in mature markets.
For investors, Lenovo presents a rare proposition: a play on China's long-term growth; a computer company that's gaining scale, share, and profitability, even as it transforms itself into a maker of higher-priced, more profitable devices. That puts the company on the cusp of a change that will bolster margins and returns for investors. Lenovo ADRs, which have quadrupled in recent years to a recent $20, could climb to $25 in the next year as demand steps up for the company's smartphones and tablets. Barron's, it should be noted, was early in recognizing Lenovo's potential, having first written bullishly about the company two years ago, when the ADRs were just above $10 ("From China, the Next Great Tablet," April 25, 2011). Each ADR represents 20 Hong Kong–traded shares (992.Hong Kong).
MUCH OF YANG'S VISION depends on China, which accounts for 42% of Lenovo's sales and the bulk of its profits. It was there, too, that Liu Chuanzhi, a Chinese Academy of Sciences engineer, and 10 buddies founded the company in 1984 as a computer reseller, one of China's first entrepreneurial ventures. Ten years later, he promoted Yang, a 29-year-old salesman from the impoverished city of Hefei, to run the fledgling PC division, a hiring that the founder would later call a "risky decision." It paid off. Lenovo introduced its first laptop in 1996, then began distributing IBM software in China. Yang dumped direct sales and started using local distributors; he also cut prices to just above cost. Eventually, he was the major driver behind Lenovo's purchase of IBM's personal-computer division, which was three times as large as his company at the time.
Lenovo has thousands of retail outlets in China. Its PCs are available everywhere, and it's the top-selling brand by far. Its smartphones are sold through the same ubiquitous retail channels and via carrier agreements.
Like tablets, smartphones are a fairly recent addition to Lenovo's product line. They were launched in China in early 2010, but not made a priority until 2011.
"In China, they have deep distribution all the way down to Tier 6 cities. So it's not surprising they already have a significant position and are giving LG and Samsung a run for their money," says Roger Kay, president of Endpoint Technologies, a Massachusetts-based market-intelligence firm. "With phones in China, right away it gets growth across the revenue footprint," even if PC sales are challenged.
Yang has shifted his "attack strategy," which had a devastating effect in the PC market, to mobile devices. Last week, Lenovo introduced the Vibe X, a premium phone, at a trade show in Berlin.
Lenovo, which makes phones using Google's Android operating system, has introduced a number of firsts that made it popular with Chinese carriers. For example, it was the initial manufacturer to pitch smartphones at women. Apparently, Chinese women prefer big phones, which make their faces look smaller and "more beautiful." And with China Unicom, Lenovo pioneered smartphones priced below $200; China Mobile and China Telecom followed suit. That helped Lenovo compete against domestic rivals, including Huawei Technology (002502.China), ZTE (0763.Hong Kong) and Yulong, a unit of China Wireless Technologies (2369.Hong Kong), says James Wang, a Shanghai-based analyst for market researcher Canalys.
Lenovo has constantly upgraded components, taking chances on partners like chip maker MediaTek (2454.Taiwan), which supplied it with powerful new processors for its smartphones before shipping its chipsets to other customers. "By taking the risk of adopting the new system on a chip first, Lenovo enjoyed first-mover advantage to local competitors," relates Canalys' Wang. One popular phone, the K900, a huge device that some wags dubbed a "phablet," has made the leap from China to India. Observers speculate that this phone may be one of Lenovo's entrants in the U.S. market.
In China, consumers frequently upgrade their phones, and that taught Lenovo a lesson it brings to its ventures in new markets. The life of a phone is "maybe half a year," says Liu Jun, Yang's protégé, point man on phones, and leader of one of Lenovo's two new divisions that are driving the company's transformation. "That's why it's a much, much bigger market than PCs."
In the past year, Lenovo introduced more than 40 smartphone models in China. "We launch more new models every month," says Yang. "And most of them are manufactured in-house, which gives us a cost advantage and also a time-to-market and time-to-volume advantage."
In the fiscal first quarter, Lenovo produced 11.4 million smartphones, up threefold from the same quarter a year earlier, and 1.5 million tablets — quadruple the number a year earlier. For the full year, the company says it expects to sell 50 million smartphones and 10 million tablets. Lenovo says its new factory in Wuhan has the capacity to turn out 100 million smartphones and tablets a year.
Lenovo's ThinkPad tablets use Microsoft's Windows 8 operating system, while the IdeaPad uses Android. The company says that it would consider making a smartphone using the Windows Phone OS, depending on demand. Asked about last week's acquisition of Nokia's mobile-phone unit by Microsoft (MSFT), Yang comments, "We've said before that we expect industry consolidation. Microsoft is, and will continue to be, an important strategic partner. We will also compete with each other. This is the nature of our industry."
YANG, 48, HAS BEEN an able steward of what is arguably China's first global brand, ensuring that the halo from IBM's premium products didn't wear off. The company kept Lenovo as the brand for its consumer products; high-end enterprise PCs sport the ThinkPad brand. And he hired a roster of capable Western executives to help run the company. The corporate integration was so successful it was lauded by the Harvard Business Review.
Committed to leading a global company, Yang began learning English right after the IBM deal, studying with a tutor and watching endless hours of CNN. He brought his family to live near Morrisville, N.C., the site of IBM's former PC headquarters — and now one of Lenovo's two headquarters. English is the company's official language.
Known as YY to Lenovo's 30,000 workers, Yang is a popular leader. At a recent meeting in nearby Raleigh, attended by thousands of Lenovo's sales employees in the Americas, workers were enraptured by Yang's vision for the company. "It's your turn" for applause, he told them. He also has the populist touch. Last year, he gave his $3 million bonus to employees. He did the same again just last week. He can easily afford to: His 7% stake in the company now is worth $700 million.
It was Yang who yanked Lenovo back from the brink with his Protect & Attack strategy, introduced right after the 2008 crisis. Under Protect & Attack, Lenovo would protect markets like China that were cash cows, and attack fast-growth geographies and new products. Attack businesses are expected to grow at twice the market rate, but even protect categories must grow faster than the market. Lenovo requires profitability only once a category has reached double-digit share.
For employees, Protect & Attack would become a mantra, a way to organize business planning. Says Beau Skonieczny, a computing analyst at Technology Business Research: "One of the biggest changes in the last couple of quarters is they shifted PCs into the protect mode," which will create cash to fund other operations.
Under Yang's new strategy, known as PC-Plus, Lenovo has shifted its "attack markets" to mobile devices. This spring, Yang reorganized the company to address its "attack markets" head-on. Yang believes that even the strongest contenders aren't invincible. Samsung successfully attacked the Apple ecosystem, demonstrating that Android could win. Gerry Smith, a former senior executive at Dell who now heads Lenovo's Americas group, says he and his colleagues knew what to do from there. "We know the playbook; we've done it on PCs," he says. "When I've seen Samsung be successful over the past couple of years, I've just smiled and said, 'This is great,' because this gives us an opportunity to go after the market leader. We can attack on scale. We'll attack on cost efficiency and speed. We can attack these guys from the bottom, and put a lot of pressure on them from a product portfolio, pricing, time-to-market perspective."
Samsung did not respond to a request for comment.
BY THE END OF THIS YEAR, Lenovo plans to introduce a raft of new products; last week it began with a new premium phone, the Vibe X. It has been pushing convertible devices like the IdeaPad Yoga, a tablet and PC amalgam: The IdeaPad is heavier than a tablet and has a shorter battery life, but offers more computing power. In the U.S., Lenovo sells it through Best Buy and Staples, where it dominated the Windows 8 personal-computer market late last year, with 29% of the $700-and-above machines and 49% of the $900-plus.
Lenovo maintains that tablets are transitional devices that will eventually converge with smartphones: Yang thinks anything with a seven-inch screen will be dubbed a tablet, while anything with a smaller one will be called a smartphone. That means consumers will choose products based on functionality (such as portability), rather than type of device.
While the global market for PCs may have peaked, demand is stabilizing in China, and enterprise customers need to refresh their machines. Yang expects an additional quarter of weakness in the global PC market, perhaps two, and then stability.
In the U.S., the PC remains the primary computing device for most people. A recent IDC study showed that individuals spend half of their time on PCs, versus 30% on smartphones. And 54% of the Millennials — people born between 1977 and 1994 — plan to purchase a PC in the next year. "We sold black boxes to CIOs; now we're selling to 18-to-24-year-olds," says David Roman, Lenovo's chief marketing officer.
"You can't call the PC irrelevant," says Tim Bajarin, president of Creative Strategies, a San Jose, Calif., consulting firm, who also serves on an advisory council for IBM and Lenovo. "It's such a workhorse in business, in education, and it plays a role in people doing their bills, kids writing reports, managing their media, stuff you could never do with a tablet."
The rap against Lenovo is its razor-thin profit margins. Its operating margin is 2.4%, under the 5.4% of troubled Dell and far, far below Apple's 29%. Yang has vowed to add at least a point. And earnings will pile up as the company continues to drive PC-Plus. Smartphones are a fatter-margin business than PCs, and people buy them more frequently.
Servers and storage, which account for just 3% of Lenovo's sales, could also boost profits. With Lenovo's goal of getting to a double-digit share in each of its businesses, an acquisition seems inevitable. Lenovo was negotiating to buy IBM's low-end X86 server system this year, which has much higher margins than Lenovo, but it's understood that Big Blue wanted a much higher price than the Chinese outfit was willing to pay. Those talks appear to be on ice for now, but could revive.
LENOVO BULL JAMES WEIR, a portfolio manager at Guinness Atkinson Funds, says the performance of the company's core businesses is heartening. "They are gaining market share in a very flat market for both desktops and notebooks. The potential for rerating is in the smartphone and tablet businesses," which accounted for 14% of revenue in June, up from 11% in December. Profitability in the businesses — Lenovo is already in the black in Chinese smartphones — will drive earnings higher. "If Lenovo can keep growing this, they can earn the right to be rated with Apple and Samsung as a sexy consumer electronics player, not just a PC box seller. What P/E would investors pay for a 'Chinese Apple'?" Weir asks.
Yang points out that Lenovo has a market value of $10 billion. "What is Apple? $400 billion?" (A recent run has put it closer to $450 billion). That puts the U.S. tech giant at 45 times Lenovo's market value. Some who believe in Lenovo's strategy argue that the company can eventually rival Apple or Samsung in size
Preposterous? Perhaps not.
Muses Peter Hortensius, an IBM veteran who oversees Lenovo's high-end PC-Plus efforts: "If you thought back to 2009 and heard us say, 'Hey, we are going to take on HP and Dell,' people would have said, 'C'mon, no way.' Four years from now, we'll be sitting here, and the battle will have been fought. I'd like to think we'll be successful at it."
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