iBooyah.com Investment Matters

Buying companies with simple business models where revenue generation is transparent and sustainable over the long term is one of Mr. Buffet’s fundamental strategies.  Another important factor to consider is the company’s market position. Corporations that holds a monopoly represents the best opportunities.  How the company manages the free cash flow is also important. Are they leaving it in the bank or investing it back into the business or are they using it to buy back shares?  These are important considerations when evaluating companies. Personally, I am not a big fan of companies that pay out dividends.  My preference is to have the company continue to invest in the business.

Getting back to our original topic, despite the best efforts of our government to break up monopoly, there are several that remain.  Microsoft Corporation (MSFT) is a classic example of today’s monopoly.  Let’s evaluate the company’s strengths, weaknesses, threats and opportunities (SWOT).

Strength

Despite how we might feel about Microsoft’s business practices and the Windows Operating System (OS), we must recognize that MSFT Windows runs on about 95 percent of the world’s computers.  The other 5 percent is running on the UNIX Operating System, Linux and MacOS. Moreover, MSFT also monopolize the word processor, spreadsheet and browser market to name a few.  This monopoly over the desktop has and will continue to provide Microsoft the strategic advantage over competitors. 

Looking back at the history of Microsoft, the company has been successful at coming from behind and over taking its competitors.  We saw this with the internet browser where MSFT bundled Internet Explorer along with the OS and eventually killed Netscape.  Prior to that, they killed WordPerfect and Lotus using the same tactic.  Another obvious strength is MSFT’s ability influence the technology sector.  A great example of this is when the company decided to omit Sun’s Java technology (SUNW) and came up with a similar technology of its own, thus slowing Java’s growth.  Other examples include forcing computer manufacturers to not include competitor’s applications.

The monopolistic power in which Microsoft holds is the primary reason I believed the company will eventually win out in the end.  The government can do little as witnessed by the outcome of the MSFT vs. Netscape trial during the late 90’s.  Furthermore, with a pile of cash, this company can afford to wait and capitalized on the mistakes of competitors.

Weaknesses

Despite the monopolistic power, there are weaknesses that investors should consider.  Due to Microsoft’s size, the company’s ability to launch new products in a timely manner has proven to be a challenge.  This is evident with the delays of the Longhorn and now Vista.  The size of the company has proven tough for management’s ability to execute their strategies.  This was recently exposed when the company announced they will be spending additional $2 billion on research in an attempt to catch up to the likes of Google (GOOG) and Yahoo! (YHOO). Microsoft’s ability to innovate has been called into question and is usually late to the game. A prime example of this weakness is with internet search where MSFT ignored this market for a long time.  Furthermore, MSFT battle with the European Union (EU) over its monopoly appears to have no end in sight.

Opportunities

The company’s cash balance of nearly $40 billion provides MSFT with many opportunities.  The fact that they have a monopoly on the OS also helps.  This is a company that can afford to keep their stock prices at a certain level through their stock repurchase plan. Not many companies have this ability.  With the release of Vista, there exist the opportunity to catch up in areas where it is currently lagging, such as the internet search business. Don’t be surprise if Vista’s desktop is actually a search box.  The digital conversion where our televisions and computers will eventually merge is the next opportunity for Microsoft.  This strategy appears to be well on the way. Vista appears to be launching pad for this new market.  MSFT can easily dominate given it appears to have a head start.

Threats

Technology is always in a constant state of change.  The shelf life of any given technology is equivalent to that of a banana.  Microsoft constantly faces threats from emerging technology that is capable of replacing its operating system.  The open source initiatives where companies are now opting to deploy products based on non-proprietary technology is growing. This is evident in the growing number of Enterprises that have deployed Linux.  While the number of Linux remains small in comparison to Windows, these types of threat will continue as technology evolves.  Another threat facing MSFT is itself.  The company is no longer nimble, thus no longer able to react to changes in the market as it once was able to. If this were any other software company without the monopolistic advantages, it probably would not exist today.

Summary

Monopoly is great when it comes to investing.  This is the very strategy that made Mr. Buffet the god of investing that he is.  Buying a monopoly at its low point is a smart thing to do. Consider this; MSFT will not go out of business in the foreseeable future. In addition, the recent announcement to buy back up to $20 billion of shares is like a safety net. The company’s stock is currently trading between $23 and $24.50, which is about 20 times their expected earnings.  This is inline with the company’s year over year growth rate.  In my view, this represents a great opportunity to buy MSFT.  Once the next version of their Operating Systems is release (ETA of Vista is January 2007), this stock could easily be in the high 20’s and possibly mid $30 range.

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