Microsoft MSFT
December 23, 2008 - 3:11pm EST by
fiftycent501
2008 2009
Price: 19.14 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 170,262 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

Sign up for free guest access to view investment idea with a 45 days delay.

Description

In this environment, owning self sustaining cash flow generating companies with defensible franchises and great balance sheets is more important than ever. MSFT is arguably one of the world’s best businesses. It boasts great margins and generates enormous free cash flow of $18.4 billion in F’08 and more than $17 billion expected in F’09. It has near monopolistic market shares on the corporate and consumer desktop and laptop markets, as well as great brand recognition. All of this combined with low capital requirements has lead to stellar returns on invested capital, 26% over the past 5 years and in the low 40’s more recently.  The stock has never been cheaper on any metric, trading at approximately 10x F’09 net income.  The current bear market is giving us the opportunity to buy a great company at a great price.
 
There are certainly risks associated with MSFT. Clearly consumer and enterprise spending will slow due to the recession. Longer term there are also risks to the franchise from competition from the likes of Linux and GOOG, among others, as well as questions regarding execution and strategy in areas like online search and consumer entertainment. There are also risks associated with capital allocation (YHOO acquisition, etc.). These concerns have all been widely documented and I believe at this valuation have been more than priced into the stock.  
 
Despite these risks, I believe the stock is very cheap and its franchise value will endure for longer than the market is currently giving MSFT credit for. Even though the business is maturing sales and income growth has still been quite strong over the past few years. Historically MSFT has not been impacted to a large degree by economic cycles, although I expect this cycle pose more of a challenge to MSFT. The competitive threats are real, but MSFT’s market position is virtually unassailable in some of its key markets.  Furthermore, online and consumer divisions have been masking overall corporate profitability because they are still in a heavy investment phase, so these have been a drain on earnings, but at some point could turn around. As for capital allocation, a dilutive acquisition is still possible, although it seems less likely at this point, and MSFT has a great track record of returning value to shareholders. The company currently has a 2.7% dividend yield and has plans to buy back $40 billion of stock.  Over the past 5 years it has returned $115 billion to shareholders via buybacks and dividends
 

Price

$19.14

SHSO

8895.6

MCAP

170,262

F2008

F2009

Cash

20,722

6.5

6.7

EV/EBIT

Equity and other investments

4,381

5.7

5.7

EV/EBITDA

Debt

1,975

12.5%

11.9%

FCF Yield

EVAL

147,134

expected-->

9/07

12/07

3/08

6/08

9/08

12/08

3/09

6/09

1Q'08

2Q'08

3Q'08

4Q'08

1Q'09

2Q'09

3Q'09

4Q'09

Revenue

13,762

16,367

14454

15837

15,061

16,500

14,000

15,000

COGS

2,675

3,543

2514

2866

2,848

3,300

2,590

2,775

GP

11,087

12,824

11,940

12,971

12,213

13,200

11,410

12,225

R&D

1,837

1,885

2035

2407

2,283

2,459

2,212

2,370

S&M

2,683

3,392

3155

3878

3,044

3,746

3,332

3,630

G&A

718

1,066

2341

1002

887

1,139

966

1,035

Opx

5,238

6,343

7,531

7,287

6,214

7,343

6,510

7,035

Op Inc

5,849

6,481

4,409

5,684

5,999

5,858

4,900

5,190

DA

435

481

532

608

585

627

532

570

EBITDA

6,284

6,962

4,941

6,292

6,584

6,485

5,432

5,760

SBC

333

360

373

413

443

396

378

405

EBITDA2

6,617

7,322

5,314

6,705

7,027

6,881

5,810

6,165

expected

2006

2007

2008

2009

Revenue

44,282

51,122

60,420

60,561

COGS

7,650

10,693

11,598

11,513

GP

36,632

40,429

48,822

49,048

R&D

6,584

7,121

8,164

9,324

S&M

9,818

11,455

13,039

13,752

G&A

3,758

3,329

5,127

4,027

Opx

20,160

21,905

26,330

27,102

Op Inc

16,472

18,524

22,492

21,947

DA

903

1,440

2,056

2,314

EBITDA

18,528

19,964

24,548

24,261

SBC

1,715

1,550

1,479

1,622

EBITDA2

20,243

21,514

26,027

25,883

CFFO

14,404

17,796

21,612

20,591

Capx

-1,578

-2,264

-3,182

-3,028

FCF

12,826

15,532

18,430

17,563

 


 
My 2009 estimates are based on weakening PC demand, continued share gains by netbooks, and deteriorating consumer spending trends.  Management has guided revenue to $64.9-66.4 billion. F2Q’09 appears to be shaping up fine, but management will most likely have to lower guidance for the balance of the fiscal year.  Client revenues will probably end up declining in the mid single digits for the year, as netbooks take share and PC’s are weaker. OEM will also decelerate based on weaker PC shipments.  The business segment should also feel the pain of the recession and credit environment, but it can still post mid single digit revenue gains. Server and tools should be relatively strong even with the prevailing headwinds as it has a large recurring portion and a strong balance of unearned revenue. Online and consumer should continue to grow, albeit at a much slower pace.  

 
I have taken a realistic worst case scenario cut to management’s guidance, but this still leads to nearly flat revenues. It also means that MSFT could generate operating income of almost $22 billion and free cash flow of over $17 billion. A DCF using a 10% cost of capital and 2% terminal growth yields a valuation in the high $20s for the stock, which seems reasonably conservative as it translates into roughly10x EV/EBIT and 8% free cash flow yield on F’09 estimates.

Catalyst

moat, valuation, div, buyback, the world not ending
    show   sort by    
      Back to top