Tuesday, February 10, 2009

Microsoft Requires Sprint

We have mentioned in previous posts that part of this activist campaign involves the acquisition of Sprint. In the recent article by Microsoft SubNet titled "Angry shareholders say Microsoft is squandering billions on R&D" it mentions the campaigns intention for Microsoft to acquire Sprint. This article can be accessed at http://www.networkworld.com/community/node/38350

In this post we wish to further examine and explain the rationale for this acquisition.

Microsoft based its current business model on software and hardware. It has dominated OS, Server and Tools and Business Software. However, each of these divisions account for the majority of the company annual revenue.

Client (28% of revenue and 45% of income): The client segment, accounting for approximately 28% of total revenue, includes sales and marketing expenses for the Windows operating system. 80% of this revenue is from the sale of products with pre-install versions of Windows operating systems.

Server and Tools - Products for IT Professionals (22% of revenue and 16% of income): The Server and Tools segment, which accounts for approximately 22% of Microsoft’s revenue, develops and markets software server products, services, and solutions such as Windows Server 2008 and Visual Studio 2008. Approximately 45% of Server and Tools revenue comes from multi-year licensing agreements, 25% through fully packaged product and transactional volume licensing programs, and 10% from licenses sold to original equipment manufacturers (OEMs).

Business (32% of revenue and 42% of income): Microsoft Business Division (“MBD”), accounting for approximately 32% of Microsoft’s revenue, includes the Microsoft Office system (about 90% of MBD revenue) and Microsoft Dynamics business solutions. Approximately 80% of MBD revenue is generated from sales to businesses, the rest being derived from sales to consumers.

Therefore, these three company divisions equate to approximately 80% of the company revenue. Subsequently, over 3/4 of the company annual revenue is contingent upon three divisions. However, if the company continues to lose share in OS and consumers move towards SaaS both Client and Business divisions will potentially lose substantial revenue. This will prove detrimental to the company stability and ultimately shareholders.

In a previous post we referred to the potential failure of Windows 7. We outlined an article by Mitchell Ashley located at http://www.networkworld.com/community/node/37956

What is of greater interest and potential concern for Microsoft is the article by Joseph Tartakoff located at http://blog.seattlepi.nwsource.com/microsoft/archives/161740.asp
The most interesting portion of this article is the following comment from an analyst:

In an interview, IDC Analyst Al Gillen said that Microsoft's advice was unsurprising.
"What they're warning is: Don't look at (Windows) 7 as a silver bullet that makes (the) challenges of going from XP to Vista go away," he said. "Windows 7 may have a new product name but it's really Vista Release 2. That's how a customer needs to think about it."

In our last post "Apple Vs Microsoft" we stated that consumers are moving towards netbooks, cloud computing and handheld devices. Each of these trends threaten Microsoft's current business model. The company is required to transition into these sectors to remain competitive. As outlined within the Microsoft Subnet article located at http://www.networkworld.com/community/node/38350

The attempted Yahoo bid was perhaps Microsoft's bloundered attempt to secure a position within this environment. However, as argued in past posts, an affirmed by analysts, Microsoft can achieve this required strategy through a "search" only deal.

The company is also confronted with the transition to netbooks and handhelds. As mentioned within a previous post and also the Microsoft SubNet article, Citi analyst Mark Mahaney indicates that through the Verizon deal that each consumer is required to conduct 17 searches for five years for Microsoft to break even on the alliance. This fails to translate into steller revenue growth for the company. Numerous analysts predict that the multiple alliances are an attempt to secure marketshare. However, the marketshare will fail to translate into revenue which the company requires for survival. As mentioned in a previous post "Interview with Microsoft SubNet" we argue that alliances fail to provide the company with complete control of the asset. Analysts and shareholders recognise that the company cannot continue to substantially grow OS and Business. Therefore, it is critical that Microsoft seek to capture a competitive share of cloud computing, SaaS and handheld devices.

In the most recent Microsoft Subnet article Mr. Barnicle argues that the acquisition of Sprint is similar to the Comcast investment. However, we will refer to a recent article in the Wall Street Journal.

The article references that this investment was intended to be strategic. However, it failed primarily for two reasons. First, the video delivery never materialized. Secondly, the programming only occured within the Seattle area. Microsoft despite the investment failed to have complete control of the investment.

Microsoft created an alliance with Verizon and other carriers. The fundamental dilemna is similar to the Comcast investment. Although Microsoft has invested in Verizon, there is the potential that there will be a similar outcome to the Comcast investment. Despite Verizon being a strategic investment, there is a probability that it will fail to have a significant return.

It is more beneficial for Microsoft to control the investment. Therefore it is more beneficial for Microsoft to acquire Sprint than create strategic investments in other companies. If Microsoft acquires Sprint, it has complete control of the strategic investment. Therefore, if Microsoft intends to place MSN in all mobile phones it has the potential as oppossed to Verizon eventually not completing the alliance terms.

When preparing this campaign and conducting research we considered other mobile companies. We considered Microsoft pursuing RIM. However, upon further consideration we perceived this acquisition to be similar to some of the problems with the Yahoo bid.

It seems without speculating that the Yahoo bid was Microsoft's attempt to capture a larger share of advertising/search/cloud computing. The acquisition of Yahoo would have provided Microsoft with an increase in marketshare. It would have enabled Microsoft to increase marketshare from approximately 6-8% of the market to approximately 30%. This would have made the company more competitive with Google that controls over 50%. Regardless the acquisition would have reduced the margin between competitors.

The main dilemna with the acquisition was the astronomical cost to achieve marginal gain. The bid was valued at $45 billion. It would have increased the company marketshare. However, the deployment of $45 billion would have added only $7 billion in revenue. This revenue estimate is based on Yahoo annual report.

RIM, similar to numerous companies has expereinced a decline with its share price. In 2008, at the time of research prior to this campaign, the share price was trading at approximately $40 per share. This equated to a market valuation of approximately $20 billion. The company according to its annual report generated approximately $6 billion in annual revenue.

During the same period of examining RIM we reviewed Sprint. In 2008, Sprint was trading at approximately $3 per share. This provided the company with a market valuation of approximately $7 billion. However, the company generates approximately $40 billion in annual revenue. It proved more prudent to acquire Sprint than RIM. If RIM shares remained flat at the November 2008 level Microsoft would be required to spend approximately $25 billion (this equates a modest premium). The acquisition would provide Microsoft with $6 billion in revenue.

The second fundamental dilemna is the lack of consumer confidence with Microsoft. The company fails to have the same brand recognition as Apple or RIM. Therefore, if Microsoft acquired RIM, there is the potential that the investment would flounder based on consumer perception. Additionally, would RIM be able to survive and remain innovative under the ownership of Microsoft?

The acquisition of Sprint ensures that Microsoft captures 40 million existing Sprint consumers.

Based on this analysis that is confirmed through other investors interviewed for the Microsoft Subnet article, Microsoft is required to trim its R&D spending. It is still fundamental to invest in SaaS, cloud computing and handheld services. However, if the company trims its $8 billion in R&D and directs a portion towards reducing Sprint debt it would improve the value of the acquisition.

Through alliances Microsoft lacks the ability to cross-promote products. As mentioned in previous posts imagine Microsoft being able to offer the corporate client OS and Business software but also be able to offer mobile services for the consumer company executives. Therefore, current OS, Server and Tools, and Business consumers could be offered a valuable cross-promotion of mobile services for its employees. This would provide Microsoft with a powerful competitive advantage over companies such as Google.

The acquisition of Sprint provides the company with 40 million subscribers. It provides Microsoft with $40 billion in revenue. It can be acquired through current market valuations for approximately $7 billion. Microsoft can utilize cash flow to improve Sprint's balance sheet and make the company more financially stable. Additionally, it provides Microsoft with complete control of the asset.

This acquisition would enable Microsoft to accelerate its presence into the handheld sector. It would enable Microsoft to own the third largest carrier providing the company with substantial marketshare.

Acquiring Sprint is necassary for Microsoft to transition into the handheld sector. Without the acquisition there is the potential that Microsoft will fail in transitioning into this sector and securing the required marketshare and revenue to remain competitive.

We may be contacted at thecrandreagroup@hotmail.com

Recent addition:

It has been an effort and strategy to attract Microsoft employees to provide insight and analysis into the dilemna's confronting the company.

This following comment is from a Microsoft employee. It provides tremendous insight and analysis into which mobile company would prove more advantageous for Microsoft to acquire.

I visited they-who-shall-not-be-namedr's site, and it seems like they've put some thought into their analysis.

A Sprint acquisition doesn't strike me as particularly prudent, because that brand's reputation is not something MS needs right now. If they think Vista has damaged the MS brand, they really won't like what being associated with Sprint will do to the brand. Talk about a pile of customers who dislike their vendor but stick with them because they're the low-price solution... I believe Sprint has the lowest CSAT and worst reputation of any major carrier in the cellular provider industry, and tremendous subscriber churn, which would mean MS would have to get good - fast - at acquiring new customers without spending an arm and a leg (Live Search Cashback anyone?) in SAC (subscriber acquisition cost). This isn't something MS has shown themselves to be very adept at recently, in niches other than Xbox.

In contrast, RIM is a much sexier company with a good degree of loyal "addict" mindshare, which provides a more profitable moat with less price elasticity than Sprint's low-cost-provider-based moat. It would boost the MS image, even if it requires a more significant investment. And MS' recent difficulties attracting new customers wouldn't hurt as much here, because of the loyal user base and the inherent attractiveness of the RIM platform to those who consider themselves more "business people" than "technologists". Absent a telco willing to pay MS for new customers (AT&T / Apple iphone), if MS is intent on playing in the mobile space, it might be worth trying something disruptive in the market. After all, what MS has done so far hasn't been resoundingly successful.I also like RIM because they've been running a successful service business -- along the lines of the cloud computing model -- for an extended time. MS might be able to learn something from studying what they've done right.

Another reason to avoid Sprint, and Verizon as well, is that those companies use CDMA cellular technology, as opposed to the GSM technology in use in most other countries. I think MS would get more bang for the buck in an investment that is so focused on the largely-US-specific CDMA world.

And now to get this back somewhat on topic (mini msft, lean and mean). Brief web research nets that Sprint has over 50,000 employees and RIM has less than 10,000. If you had to select a sinkhole to throw cash into, with some hope of ROI, would you rather it be a sinkhole requiring 10,000 additional paychecks, or 50,000?

Consider that MS already owns Danger, maker of the Sidekick. Acquiring the Blackberry platform would mean that MS would have presence in both the "youthful consumer" and "business" segments of the cellular communication device market. This has the potential of annoying the OEMs, but consider that MS has had Danger for a while so far and has not to my knowledge lost any OEMs because of it. And RIM is far more than just the phone hardware -- it's the Blackberry service as well.

While I don't necessarily agree with everything the activists propose, I'm also not on the side of doing nothing. If these people are willing to do the work to try to get something to happen, I'm not going to stand in their way. And if they do get something to a vote, I might even vote their way, although the chances of that are much greater if Sprint is not the acquisition target.
By Anonymous, at 1:15 PM

In this post it is argued the logic of preferring Sprint in comparison to RIM. In the Microsoft SubNet article Mr.McDonald ( a shareholder since 2000..when the shares were worth approximately $36 per share) agrees that Microsoft is required to acquire a mobile company. However, Mr. McDonald prefers RIM instead of Sprint. This opinion is greatly respected and appreciated with this campaign.

The author of the above extracted comment also prefers RIM. Does RIM provide greater value to Microsoft?

Here are a couple more comments from Microsoft employees extracted from Mini:

In contrast, RIM is a much sexier company with a good degree of loyal "addict" mindshare, which provides a more profitable moat with less price elasticity than Sprint's low-cost-provider-based moat. It would boost the MS image, even if it requires a more significant investment. And MS' recent difficulties attracting new customers wouldn't hurt as much here, because of the loyal user base and the inherent attractiveness of the RIM platform to those who consider themselves more "business people" than "technologists". Your supposition regarding the possible acquisition of RIM is fascinating and I think the potential for strong synergy is obvious. In addition, considering the recent and planned layoffs at Microsoft, I can think of many Microsoft employees, present and former, who, if this acquisition successfully occurred, would probably enjoy having a RIM job, as opposed to having no job.
By Anonymous, at 4:40 PM

Another comment concerning RIM:

Anonymous at 4:40 said:I can think of many Microsoft employees, present and former, who, if this acquisition successfully occurred, would probably enjoy having a RIM job, as opposed to having no job.This member of the 1400 would enjoy having a RIM job, period. To work for a company with rabid fans as customers is an energizing, exciting career experience. Most such companies recognize the value of this rabid fan base, and actively work to not disappoint or alienate it. Yeah, there's real-world customer focus based on units sold and the word of mouth vibe, not the type where customer sat is calculated by vendor-initiated polls. Been there, done that, had fun building products that customers couldn't wait to get their hands on, and would do it again.

And to the Crandea (spelling?) people, buying RIM is not analogous to buying Yahoo. To many engineers, YHOO is a company that peaked ages ago, like Sprint is well past its prime, and is full of many people who rather actively dislike (hate) MSFT. RIM is still riding its wave, and that's why it commands a premium. It's WORTH more. The more I think about that RIM analysis posted earlier this week, the more I get where the guy is coming from.A simple metric. I'm an engineer. I would not go out of my way to apply for YHOO, even though since I'm one of the RIFfed 1400, it may eventually come to that. In contrast, RIM makes my short list and I have already made inquiries there. RIM is likely to get MSFT more raw, engineering talent as well as SaaS business savvy. The company needs more agile people who are used to working in a "make or break your P&L on your own, we're not your personal VC" way, and fewer politicians, in order to turn around.
By Anonymous, at 1:17 AM

Will it remain competitive and innovative through Microsoft ownership?

RIM has a popular brand, however, would that become instantly diminished or tarnished with a acquisition by Microsoft?

Microsoft is required to pursue a mobile company to remain competitive within the handheld sector. As mentioned, Citi analysts Mark Mahaney and other analysts agree that alliances will fail to prove advantageous and beneficial for Microsoft.

Should Microsoft pursue Sprint based on capital required for the acquisition, potential revenue and solid subscriber base or should it pursue RIM with a strong consumer base, lower revenue but high brand recognition?

Based on some of the insight from Microsoft employees, perhaps RIM is more advantageous.

1 comment:

Anonymous said...

MS needs new management, not new ventures. And they'll probably start by consolidating rather than expanding.