Monday, July 6, 2009

Eric Jackson of Ironfire Capital

In past blogs we have made reference to Eric Jackson of Ironfire Capital. In 2007, the firm acquired less then 100 shares of Yahoo. Utilizing the Internet the firm implimented "Plan B" and rallied support from frustrated Yahoo shareholders.

Mr. Jackson has a blog called Breakout Performance. In this post we wish to provide the article Mr. Jackson posted on June 10. The article reiterates what this campaign has been stating regarding R&D spending and a reality check.

Eric Jackson

A couple of weeks ago at the D7 Conference in Carlsbad, Calif., Microsoft(MSFT Quote) CEO Steve Ballmer boasted the software company could create a lot of new things by spending $9.5 billion annually on research and development expenses. That's right, Microsoft spends almost $10 billion each year on R&D. That's more than any other company in the world, by a long shot.R&D spending at many tech, pharmaceutical or biotech companies is treated as motherhood and apple pie. R&D is never a bad thing -- it's only good. More is always better.

When you invest in research, you are investing in hope and possibilities. No matter how much you have lost in past projects that never panned out, every new dollar invested in a R&D project holds the possibility that it will deliver a large multiple of that dollar in future earnings before interest, taxes, depreciation and amortization.

Spending a lot on R&D would be a good thing for Microsoft if it was generating a large return from that investment. But that's not the case and it hasn't been the case for a long time.Ballmer's comments show that Microsoft's senior leadership is proud of its continued investment in R&D and sees it as a source of competitive advantage for the company. On an absolute dollar comparison basis, Microsoft is making a much bigger bet than most in this area.Microsoft spent 46% more than the $6.5 billion IBM(IBM Quote) invested in R&D last year, 252% more than Oracle(ORCL Quote) ($2.7 billion), 763% more than Apple(AAPL Quote) ($1.1 billion), and 390% more than Google(GOOG Quote) ($2.8 billion).

Yet, most would conclude that Microsoft isn't 9 times as innovative as Apple, despite the discrepancy in how much money it is pouring into its research activities. Beyond its Office, Client, and Server core franchises, it's difficult to name innovations associated with Microsoft.

What is also remarkable about Microsoft's spending on R&D is the cumulative total racked up over the years. In the last 10 years, Microsoft has invested $62 billion in the R&D area. Microsoft could have bought back nearly 40% of its stock with that amount; it could have beefed up its dividend; it could have made a string of acquisitions which presumably would have continued to grow its top and bottom lines more than what it has achieved organically.It's hard to know exactly what Microsoft has delivered for its R&D investment; it doesn't break out the numbers according to its five business segments. However, the two smallest business segments -- Entertainment & Devices, which includes the Xbox, Zune, and Windows Mobile software groups, and Online Services, which includes Search, and the Microsoft MSN, Hotmail, and Messenger properties - likely have taken the lion's share of the investment. Combined, these two divisions have delivered $71 billion in revenue for Microsoft over those 10 years and $15 billion in losses.

So, what Microsoft's $62 billion R&D investment has led to a $15 billion loss for at least those two businesses in 10 years.Ballmer has argued that Wall Street investors are too focused on the short-term. One large Microsoft investor told me recently that Ballmer had complained loudly to him about the short-sightedness of investors who called on the company four years ago to do a large stock buyback and pay out a dividend with the excess cash on Microsoft's pristine Microsoft balance sheet.

Ballmer apparently said to this large investor: "We did everything they asked for. We did a huge buyback. We did the biggest one-time dividend ever. And what good did it do us?"Ballmer's right. Total shareholder returns, or TSR, for Microsoft since it initiated its stock buyback and dividend program are down 25%. For the last 10 years, TSRs fell 47% (as of early April). This includes returns from dividend payments (including the big, one-time dividend of $3 a share), as well as stock appreciation, over that time.Is 10 years a sufficient amount of time for a shareholder to wait to judge a company's management team for how it has performed?

Those TSR numbers are clearly unacceptable and likely reflect poor investment decisions and loss of confidence by shareholders in the future prospects for the company.Over that same 10-year time period (again, as of early April), Apple's total shareholder returns have been 826%, Nintendo's have been 243%, Oracle's have been 166%, IBM's have been 3%, and Nasdaq's returns have fallen 37% -- all substantially higher than Microsoft's TSRs.

If the predominant Microsoft strategy of investing more in internal R&D, steering away from acquisitions, and keeping tight control of the five business segments has led to these results in the last 10 years, should shareholders expect that the same approach will lead to different results in the next 10 years?

Are we being "short-termists" or "flippers" of the stock by pointing out these results and suggesting they should have been much better?

R&D spending can lead to blockbuster returns. And Microsoft has a big advantage relative to its competitors in that it can invest enormous sums for future product development. But Microsoft, in being proud of the fact that it can spend almost $10 billion a year on R&D, is like a driller of oil and gas being proud of the fact that it can drill thousands of dry holes. It doesn't matter what you spend on R&D; it only matters what return you make from that investment for your investors. So far, Microsoft hasn't delivered on its promises.

A private-equity investor friend of mine once told me that he only liked investing in companies who practiced "small 'r' and large 'D' R&D" - meaning he wanted to see fewer ivory tower white coats and more of an emphasis on taking cutting-edge ideas and technologies out of the lab and building a real product and revenue stream around it. That process requires discipline, but it can be managed.Microsoft isn't the first large company to face this challenge of effectively managing its R&D process. Hewlett-Packard (HPQ Quote) lost its way a few years ago. Pfizer(PFE Quote) and other "big pharma" companies are facing similar questions around their R&D activities.

Instead of patting Microsoft on the back for its continued spending on R&D, investors and the press should be asking, "Where's the beef?" The onus should be on the company's management to articulate why its status quo approach for running this function will lead to different results in the next 10 years. Otherwise, I can think of several better ways to spend the next $62 billion of cash flow.

This campaign fully agrees with Mr. Jacksons assessment. It is time that shareholders speakout against Microsoft and its investment practices and its strategy.

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Thursday, July 2, 2009

"Ads" Fail to Add Value

Various companies have failed to advertise and market their brand successfully. has through numerous campaigns failed to increase its brand perception. Microsoft has also fallen into this category.

It is without dispute that Microsoft suffers from a battered image. Through our research we have discovered such sarcastic comments as Microsh*!. Please forgive the vulgarity. However, with such references it is clear that the company has poor brand perception.

Part of the poor brand perception is the failure to produce and market superior products. The company has offered Vista, Zune and other failures. As one Microsoft employee stated "if we can sell garbage and get away with it we will sell garbage".

Consumers want superior products. They want products that work. They want products that offer features. They want products that don't break or crash or freeze. They want products that are compatible with other products. In most of these areas Microsoft has failed.

Microsoft has also failed in changing its image. If you suffer from a poor image the logical strategy would be to improve it through some serious PR work and campaigns. However, this is an area that Microsoft has failed miserably.

Julie Bort at Microsoft Subnet was a tremendous catalyst for this campaign gaining attention. Julie provides some insight into Microsoft and its advertising campaigns. Refer to:

Follow the link in the article to view the choices of the worst ads. The sad reality is that Microsoft continues to fail to capture consumers through advertising.

Regrading the recent IE 8 commercials refer to:;contentBody and refer to

The ads are hosted by Dean Cain. However, the most recent called "OMGIGP-Oh My God I am Going To Puke" is repulsive. Who wants to watch someone puke during a commercial. The sad reality is the ads made me want to puke. Consumers are use to brand association. Lets refer to Win 95

The Win 95 commercial was terrific. It had the Stones playing in the background. Everytime you thought of Win 95 you thought of "Start It Up". Incredible brand association. Now, the same company creates a commercial were IE 8 is forever linked and associated with Oh My God I am Going to Puke. There is marketing genius at its worst.

I think that its time Microsoft fire its ad agency?

Perhaps what is the most disconcerting with the recent ad is the message it delivers. The puke is repulsive. However, the feature it is trying to promote is watch and view Porn with privacy. Lets acquire IE 8 with "In Private Browsing" with no history so we can view PORN. Well, there is a selling feature to promote to consumers!!!

What demographic and audience is this ad trying to capture?

Is Microsoft seeking to expand its IE 8 into the prison markets?

Thankfully, the ads were yanked from the air. Yet, the company also yanked the Seinfeld and Gates ads. Yet, they said it was all part of the strategy. Well, that is certainly believable.

Why are they spending shareholder capital on such poor ads that eventually get pulled from the air?

Do they really think these ads are going to create excitement with consumers to buy the products?

Word of advice Microsoft. Revert back to creating excitement. Use brand association similar to "Start It Up". What about IE 8 with "We are the Champions" or the Beatles "Got to Get You Into My Life".

Fire Crispin Porter now?

Fire Bradley Montgomery now?

Its time to improve the company image with proper advertising and marketing. Maybe the $9 billion on R&D should be spent on making a decent advertising commercial. The past commercials aren't even worth 9 cents.

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Will Microsoft Shares Ever Show Growth

For several years Microsoft shares have remained relatively stagnant. For approximately a decade the share price has displayed minimal variation. Refer to:

This campaign has indicated on multiple occassions that several years ago at an annual shareholder meeting Mr. Ballmer stated "the shares have been stagnant but we have plans and the shares will take care of itself". Despite Mr. Ballmers confidence in the "shares taking care of itself" there still is minimal variation.

A article with CBS Marketwatch makes reference to the potential of Microsoft shares reaching a level of $35 per share. Refer to:

In this article the author states that Microsoft could become a growth stock based on two primary factors. First, the author states "would be a home run for its new search technology, Bing". Microsoft has committed approximately $100 million towards an advertising campaign to promote Bing. Research shows that its share has increased by approximately 3%. That is relatively impressive growth, however, Google doesn't need to feel threatened. Google commands over 60% while Microsoft controls 13% of the search market. Bing will have to convince numerous users to steal another 50% share away from Google. It is optimistic yet not very likely.

In a CBS Marketwatch article the author Therese Poletti refers to Bing creating competition. Refer to:
The author concludes the article stating " So the key question now among investors, as Lindsay notes, is "is Bing sustainable, or will Microsoft mess it up?"

This campaign can very simply answer the above question presented by Ms. Poletti. At the beginning of the article she references to a parody video created concerning Bing. Refer to:

According to the initial CBS Marketwatch article the second issue confronting Microsoft is "More important to Microsoft's success is a very successful launch of Windows 7, the replacement for Vista".

It is evident that Microsoft failed with its release of Vista. The Mojave Experiment failed to rejuvinate interest with Microsoft and its operating system. There are numerous reports indicating that competitors such as Apple are slowly eroding Microsoft's dominance.

Microsoft still controls over 80% of the market. However, with increased competition and an weakened economy will Win 7 bring success?

Several consumers and companies will likely remain with a current operating system as oppossed to upgrading. Additionally, this segment of Microsoft will not bring much growth. It might show modest growth, sustain growth or loss share. Regardless, this segment is not a huge growth sector for Microsoft.

This ultimately leads to the final question or comment posted by the author of the initial CBS article. The author states "It is possible that both the launch of Bing and Windows 7 will under-perform investor expectations. Microsoft shares could go back to below $15, where they traded in March, if that happens".

Bing might have created a buzz with a $100 million advertising campaign, but, it is probably not sustainable. Google is part of the culture. Bing might be the best product from Microsoft in a long time, however, its probably not good enough to dethrone Google as King of Search.

Win 7 might generate renewed licenses and consumers might upgrade, however, it will not be perceived as growth. However, if Microsoft remains with Crispin Porter as their advertising agents then Win 7 will fail to create excitement with the consumer.

The sad yet realistic prediction is most likely Microsoft will remain stagnant. Despite Mr. Ballmers "plans" and his belief "the shares will take care of itself" they will probably remain flat. Microsoft requires a "New Strategy" before it ever becomes a Growth Stock.

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