“Microsoft Is Not Adobe.” This is the reaction of analysts at Bank of America Merrill Lynch (BAML) on reports that hedge fund activist ValueAct Capital headed by Jeffrey Ubben, acquired ~0.75 percent stake or 60 million shares of Microsoft Corporation (NASDAQ:MSFT) for approximately ~1.9 billion; which represents ~25 percent equity holdings based on data from Bloomberg.
BAML analysts believed that the stock price of Microsoft Corporation (NASDAQ:MSFT) went up because of assumptions that the hedge fund activist can persuade the management of the company to achieve an Adobe-like transformation- more recurring revenues, big cloud push, and perhaps cost cutting.
The following is our rough coverage of the 2021 Sohn Investment Conference, which is being held virtually and features Brad Gerstner, Bill Gurley, Octahedron's Ram Parameswaran, Glenernie's Andrew Nunneley, and Lux's Josh Wolfe. Q1 2021 hedge fund letters, conferences and more Keep checking back as we will be updating this post as the conference goes Read More
The report on ValueAct Capital’s investment in Microsoft Corporation (NASDAQ:MSFT) pushed the stock price of the search engine giant by nearly 5 percent higher on Monday.
BAML analysts said they applaud ValueAct Capital’s move and praised the hedge fund’s track record, however they emphasized that the Microsoft Corporation (NASDAQ:MSFT)’s valuation “failed to captivate the investment community for several years” because of several reasons.
According to the analysts, the main reason is the lack of confidence in the growth of Windows in a market full of smartphones and tablets. They explained, “Windows was 55 percent op margin business in F12 (after allocating 25 percent of corporate overhead, in line with Windows rev contribution). Hypothetically, if 25 percent of the PC market falls off due to the tablet threat, that would risk ~2.75 bn of op income (a ~400bp hit to op margin). This was not the issue with ADBE’s core Creative Suite Franchise, which has a strong competitive moat (incidentally we are early fans of ADBE’s model transition).”
BAML analysts said that they like Microsoft Corporation (NASDAQ:MSFT)’s Azure Cloud initiative, but it already achieved a cloud-like revenue transformation in its $20 billion Server + Tools (ST) and $25 billion Business Division (MBD) where 55-60 percent revenues are recurring.
According to them, they are waiting for important data points on Azure’s uptake to gain a conviction that it is capable of competing against secular players in the industry such as Amazon.com, Inc. (NASDAQ:AMZN)’s Web Services (AWS).
They also believe that the Microsoft Corporation (NASDAQ:MSFT) PC business is hard to be masked with the cloud. According to them, if the company becomes the largest cloud computing company it would equate to $8 billion to $10 billion revenue within the next 3 to 5 years. They said, “That would make cloud today ~10 percent of revs and smaller in the next 3 to 5 yrs if non-cloud business grows. Adding estimated 32 percent of Microsoft Corporation (NASDAQ:MSFT) revs from annuity ST and MBD +10 percent from Cloud would still be less than 50 percent ORCL gets from recurring maintenance. Most would not call ORCL a cloud company.”
And the fourth reason indicated by BAML analysts, is the fact that Microsoft Corporation is $250 billion mega cap where the CEO and its chairman owns less than 10 percent of the company. They believe that the $2 billion investment of ValueAct Capital is not enough to command a board set to get more influence. They emphasized the fact that ValueAct owns 0.75 percent stake in Microsoft Corporation (NASDAQ:MSFT) compared with its 6 percent stake in Adobe Systems Incorporated (NASDAQ:ADBE).
BAML analysts pointed out, “There had been limited track record of successful investor prodding at MSFT…It appears shareholders can make brilliant suggestions , but it is hard for mega caps to listen to inputs on capital structure, much less strategy and product given their belief in deep schooling.”