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For Shareholders' Sake, Discipline Is Due at Microsoft


The company is spreading itself too thin, losing ground and money to competitors.

Microsoft (MSFT) shares have had a great run, nearly doubling since the market collapse last March. Indeed, Ballmer & Co. are on something of a roll, with Windows 7 sales blowing away expectations and its Office software sales showing benefits of economic recovery.

But just imagine how well the stock would be performing if Microsoft really had its sights set squarely on core businesses? Dare I say it, the company could be delivering so much more for shareholders were it not for misguided ventures in areas where it clearly lacks competency. A corporate shake-up could do wonders for the stock.

For starters, Microsoft has no business in the Internet business.While Google (GOOG) and, yes, even struggling Yahoo (YHOO), rake in buckets of cash each year, Microsoft's Internet operations keep losing money. Since 2002, the Internet services division has produced total revenues of about $20 billion, but an aggregate operating loss of nearly $7 billion. Sure, the Bing search engine has gained some market share in recent months, but in the latest quarter, the Internet division generated a loss of $466 million on top line revenue of just $581 million.

Entertainment and digital devices are another flight of fancy. Despite pouring billions and billions of development dollars into Xbox, the machine remains a distant market second place behind Nintendo's Wii. Windows Mobile operating system software for smartphones looks downright old-fashioned against Apple (AAPL), Research In Motion (RIMM), and Google's Android platforms. What's more, after more than two years of hype, there's still no sign of Zune, a supposed iPhone killer.

While Microsoft is frittering away time and money on Bing, Xbox, and Zune, it's leaving its two big cash cows -- the Windows operating system and Office business software -- exposed to competition. Think of it this way: Every new dollar that IBM (IBM), Oracle (ORCL), and Google make in this market is a buck that Microsoft may have passed up thanks to its attentions being diverted elsewhere.

Successful business strategy is about making choices. No company, including Microsoft, can do it all. Going head-to-head with competitors in every major technology arena is a formula for disaster.

In his New York Times op-ed piece last week, former Microsoft VP Dick Brass suggests that greater integration is the answer for the software giant woes. But call me crazy, here's a different idea: Instead of spending to tighten up the group's various bits and pieces, Microsoft would better serve shareholders by splitting them apart into focused, disciplined, independent companies.

Imagine it broken into three chunks. The first part would concentrate on the Windows operating systems. Of course, this would continue as a quasi-monopoly, pumping out plenty of cash, with expected sales this year of about $17.7 billion and operating profits of about $13.8 billion. Valued like a regulated monopoly utility, with an operating profit multiple of say 10, this group would be worth $138 billion dollars.

The second group would hold Microsoft's Office business software and its servers and tools businesses. This too, would be another cash cow, with about $33.9 billion in total sales and operating profits of about $17.7 billion. Valued on the same utility multiple, a separate business services and products group would be worth a staggering $177 billion.

Best of all, the heaps of cash that these two businesses generate, rather than subsidizing the less profitable parts of the Microsoft Empire, could be doled out to shareholders through large and regular dividend payments.

Finally, a third group would hold Microsoft's newfangled Internet, entertainment, and device technology businesses. Together, these businesses would strain to produce a profit in the coming year, but as a group they would deliver more than $11 billion in revenues. By contrast, Wall Street analysts have Google's 2010 revenues pegged at about $27 billion, Yahoo's at $4.9 billion, and AOL's (AOL) at $2.57 billion.

Of course, the technology group wouldn't get Google's 5.3 times sales multiple, but would probably do far better than AOL's multiple of one. Giving this group a multiple of, say, two times sales would value it at $22 billion. Importantly, jettisoning these businesses from the Microsoft mother ship could re-kindle creative juices and impose the kind of focus and discipline needed to build great products and services that consumers really want to buy.

Selling or spinning off pieces of the Microsoft empire wouldn't be an easy task -- but it sure looks like it might be worth a try. The total value of Microsoft's separate parts, plus its $36 billion cash pile, and subtracting a 15% conglomerate discount, amounts to a whopping $317 billion in market value -- or more than 28% higher than the stock's value today.
No positions in stocks mentioned.
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