Sunday, September 9, 2012

Who Is the Next Microsoft?

by Nathan Slaughter

Back in the mid-1980s, I was a bit of a computer nerd.

I was not only fluent in basic (a programming language now deader than Latin), but also probably the only kid in school who new what DOS stood for. That would be "disk operating system" for those of you who grew up in the Windows era.

So years before Microsoft (Nasdaq: MSFT) became a household name, I was a fan of the software giant. I even thought about picking up a few shares of the stock. Alas, my allowance went to things like baseball cards instead.

Not a day goes by that I don't regret it. With a staggering +13,906% return since the end of 1986, I might be basking on a yacht in the Caribbean right now. And that's why millions of investors keep a watchful eye for any rising star that could potentially be the next Microsoft.

But I'm about to let you in on a little secret: Microsoft is still a powerful wealth creator, and the market has given us a rare opportunity to turn back the clock.

Back in September 2000, there were 5.5 billion shares of Microsoft changing hands at $70. That meant the market was valuing the company at $385 billion. Today, after a 2-1 stock split, there are 9.0 billion shares trading at $25, for a market cap of $217 billion.

That's right, Microsoft is nearly $170 billion cheaper today than it was a decade ago. That's an eye-popping discount. Of course, there are plenty of stocks that have gone backwards during the past 10 years, however, most are just a shadow of their former selves.

But that's not the case with Microsoft -- which has quietly grown by leaps and bounds.

Microsoft 2000Microsoft Today
Revenue$23.0B$62.5B
Operating Income$10.9B$24.1B
Net Income$9.4B$18.8B
Fully Diluted Shares5.5B9.0B
EPS$1.70$2.10
Share Price$70$24
Shareholder Equity$41.3B$46.2B


The table above encapsulates an astounding disconnect between Wall Street and Main Street.

In the past 10 years, Microsoft's sales have surged +170% and its profits have doubled. But the shares have moved in the opposite direction, so valuations have nosedived. Back then, the stock had a P/E well above 40 -- today, it's closer to 10.

For every dollar of earnings, Microsoft shares can be had for just one-fourth of its 2000 price. And don't assume that -75%-off sticker means you're dealing with damaged merchandise. If anything, Microsoft is much stronger today.

All of this isn't lost on management, which is why, according to reports, the company will issue around $5 billion in debt to repurchase shares and hike its dividend.

And why would a company with $36 billion in cash elect to issue debt in order to do this? Simply put: with interest rates near all-time lows, it would be crazy not to. [See David Sterman's: Why the Cheap Debt Frenzy is Great for Stocks]

So, in essence, Microsoft can have its cake and eat it too. It can issue debt to buy back shares and hike the dividend, while saving its enormous cash horde (and the tax implications that would ensue) for future growth opportunities.

I know what you're thinking: "OK, the stock is cheap, really cheap -- but that's because Microsoft has exhausted its growth opportunities." Try again.

Despite its size, earnings still jumped +50% last quarter and were up +30% for all of fiscal 2010. Products like the Xbox video game console that were still in the concept stage in 2000 are now raking in billions of dollars. And the development pipeline is full of promising projects waiting to be monetized, like Natal (a game-changing technology that responds to voice instructions and tracks body movements).

Microsoft has funneled heavy resources into its cloud computing initiatives, like the Azure platform, and could emerge as a leader in this nascent field.

For now, the company is hardly gasping for air. Microsoft has already sold 175 million Windows 7 licenses (though that's still just over 10% of the world's PCs). And its Bing Internet search unit has gained market share for 13 consecutive months.

Current prices for Microsoft seem to imply the company is running out of gas. But it should actually deliver healthy double-digit earnings growth in the next five years -- not bad for a business with annual sales greater than the GDP of Ecuador.

Meanwhile, research firm Gartner is forecasting that pent-up enterprise IT spending will reach $2.4 trillion this year. That's a lot of cash up for grabs, and Microsoft will undoubtedly capture more than its share.

It's been a lost decade for Microsoft, but I'm confident the stock is about to make up for lost time in a big way. The shares could easily see gains of +50% or better in the next 24 months -- and this time, I'm not letting the opportunity pass me by.

Disclosure: Neither Nathan Slaughter nor StreetAuthority, LLC hold positions in any securities mentioned in this article.

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