Will a New CEO at Microsoft Bring Stock Gains?

Kiplinger

The announcement that Microsoft CEO Steve Ballmer will soon retire tracks the story line I laid out in my May column, "A Happy Ending for Microsoft." As I've mentioned before, when I investigate a company, I look at its story and try to anticipate the direction of the plot to determine whether the stock is worth buying.

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I bought Microsoft shares (symbol MSFT) in December 2011, figuring that Ballmer's undistinguished tenure as boss was in its last act. The stock was cheap, and Microsoft had a clear competitive advantage. Not only do the firm's operating systems drive 300 million personal computers sold each year, the company dominates the market for productivity-enhancement software with Microsoft Office. The product's Word and Excel programs are so widely used that people are likely to buy Office even if they work on Apple Macintosh computers.

Of course, corporate boards often move slowly, particularly when getting rid of a 30-year executive who has close ties to a company's co-founder (Bill Gates in this case). But the board also has a fiduciary duty to shareholders. And Microsoft's investors have been suffering since Ballmer took the helm. Although sales and profits are vastly greater than they were in 2000, Microsoft's market value has declined by nearly half. To be sure, tech stocks were in bubble territory in 2000, but many other tech luminaries -- think Apple (AAPL), Amazon.com (AMZN) and Priceline.com (PCLN) have recovered smartly. By contrast, Microsoft, at $33, trades for just 12 times estimated year-ahead earnings, a valuation that reflects investors' diminished expectations (prices are as of September 11).

After Microsoft shares jumped 7% on August 23, the day of Ballmer's retirement announcement, I was sitting on a 43% return on my investment, including reinvested dividends. But I don't think this is the last twist in the Microsoft plot. In fact, shareholders should be prepared for a tough stretch for the next several months -- maybe the next several years. Just two weeks after the Ballmer bombshell, Microsoft announced that it was buying Nokia's cell-phone business for $7 billion, and the stock promptly tanked 6%.

Turning around a company with nearly 100,000 employees can be painful and slow. Over the 13 years that Ballmer was at the helm, Microsoft morphed from a technology innovator with consumer-friendly products to a lumbering giant willing to tolerate the late release of also-ran products. Hundreds, maybe thousands, of top-level and middle-level managers will need to either shape up or be replaced before Microsoft can regain its lost prominence.

Apple Model

But patient shareholders could well be rewarded if Microsoft's story traces a familiar arc. Apple, then known as Apple Computer, drifted aimlessly after CEO John Sculley canned founder Steve Jobs in 1985. When Jobs returned as a part-time consultant in January 1997, he said he was surrounded by "bozos" in key management jobs. At the time, the stock traded for $4 (adjusted for subsequent splits).

It took several years for Jobs to put new people in key positions and revamp Apple's product line. But eventually, the company released a series of game-changing products: the iPod, iPhone and iPad. The stock now trades at $468.

I'm not suggesting that Microsoft will deliver the same astounding returns that Apple did. Visionaries like Jobs are rare. But Microsoft seems to have all the right pieces -- software, gaming systems and the global communication reach of Skype -- to return to the top of the tech sector and to deliver extraordinary profits to shareholders. All it needs is the right leader. So I'm hanging on to my shares, and I can't wait to see what will happen in the next act.

Kathy Kristof is the author of the book Investing 101. You can see her portfolio at kiplinger.com/links/practicalportfolio.

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