Wall Street’s top-ranked software industry analyst for nearly two decades, Rick Sherlund, the former Goldman Sachs now Nomura Equity research analyst has covered Microsoft since they went public in 1986. Sherlund is a personal friend of Bill Gates & Paul Allen and was a liaison between Goldman & Microsoft during his time there. In a report he published today he recommends Microsoft sell Xbox and Bing:
Sherlund of Bing:
While we like Bing as a service, we need to look at this from an ROI and strategic perspective. If Microsoft could sell or even give Bing to Facebook or Yahoo and eliminate its operating costs and get a Traffic Acquisition Cost (TAC) back to monetize the traffic that Windows/Internet Explorer or Xbox in the living room can drive to Bing, this might generate perhaps $1.0bn of profit and positive FCF rather than be a drag of a similar magnitude. If this were returned to shareholders, this could add nearly 1% incremental to the dividend yield, in our estimation.
Sherlund of Xbox:
Xbox is one of the areas of success for Microsoft and is cool to consumers, but it is perhaps time to assess whether this can ever be material to the overall company and might be more leveragable to a consumer-oriented company such as Samsung. Perhaps they would be willing to pay several billion dollars for this to leverage their substantial consumer electronics business? Shareholders might want to know if they could possibly be better off if Xbox were spun out as a separate company or sold. Either way, it is not that material to the overall valuation of Microsoft and will not likely determine the success of Microsoft going forward; it’s just not profitable enough to move the needle that much at the company.
So with Bing sold to Yahoo or Facebook and Xbox sold to Samsung, that leaves Microsoft primarily with Windows & Office. Sherlund isn’t happy about Office either:
Sherlund writes, “We believe there are many iPad and Android tablet users that would be willing to pay a monthly subscription fee for Office were it delivered on these platforms. Since Office is not available, users are finding substitutes such as Evernote, DropBox, Pages or Google Docs etc. This is bad – Office is being disenfranchised on the hottest growth platforms.”
Now we’re getting to the real reason why Sherlund has put forth these crazy ideas. ValueAct Capital recently disclosed that it has acquired about 1% of Microsoft’s shares and spent a couple billion doing so. Sherlund believes activist shareholders may force Microsoft to do not what is in the best interest of the company, but what will return the most money to the shareholders. One way of doing this will be to divide the company up, while it is at maximum value, and sell it off piece by piece. Paul Thurrott has in fact recommended this for years. Sherlund believes one way Microsoft could do is by selling of Xbox and Bing, which he believes are not core to the company and will not significantly move the stock price up.
I personally believe that selling of Bing and Xbox is the stupidest thing Microsoft could do, and it will not happen. But the threat of shareholder activism is always real and it will be interesting to watch in the coming months.