I started this Corporate Finance series leading up to this final editorial, evaluating Microsoft’s earnings call which took place July 22nd. The first article covered Capital Budgeting, and the second article covered Working Capital and Capital Structure. I’m not done covering Capital Structure, as I’m gonna end on that note like we did in our Managerial Finance course last summer. I will also cover Microsoft’s current situation in the market, their recent announced layoffs, forecasting Pro Formas and Valuation.
Let’s start things off on the hot topic of Microsoft’s layoff by saying it had to be done. Looking at the fiscal year’s data of 2012, 2013, and 2014, I will refer to the following values as percentage change or %Δ. Microsoft’s Cost of Goods Sold had drastically increased from a %Δ of 15% between 2012 and 2013 to a %Δ of 33% between 2013 and 2014. In the past two years Microsoft had doubled their %Δ in expenditures only to experience a disappointing increase of Sales from a %Δ of 5% between 2012 and 2013 to 11% between 2013 and 2014. That increase of Sales is minuscule compared to their increase in COGS. Consequently, their increase of Net Profit decreased from a %Δ of 28% between 2012 and 2013 to .97% between 2013 and 2014. You heard correct, Microsoft’s Net Profit only increased at a %Δ of .97% in the last two years; that’s treading into HTC earnings territory. Investors have reason for alarm under such pretenses, and Microsoft’s CEO Satya Nadella could only remedy the poor profitability by laying off employees and their subsequent product lines. In case you aren’t aware, Steve Jobs’s first move returning to Apple wasn’t only reducing their product line down from 60 to 4 but also laying off employees; Jobs had allegedly been known for firing anyone who’d unfortunately accompanied him in the elevator. He then rebuilt the company with new product development teams namely instituting Jony Ive’s in charge of design and producing the products we know today like the iMac, iPod and eventually iPhone and iPad. To the contrary of popular scrutiny, Nadella laying off the 18,000 employees isn’t a sign of defeat but rather a sign of a more focused Microsoft in re-establishing it’s core as he had noted in his memo weeks ago.
To justify Microsoft’s reduction in product line, let’s evaluate the percentage change in the Balance Sheet’s Ratios. Microsoft’s inventory turnover ratio had decreased from a %Δ of 64% between 2011 and 2012 to 40% between 2012 and 2013 to 32% between 2013 and 2014. Their %Δ inventory turnover ratio had decreased by half in the past two years which means Microsoft isn’t moving nearly as many products. Microsoft’s Net Fixed Assets Turnover ratio had decreased from a %Δ of 8% between 2011 and 2012 to 7% between 2012 and 2013 to 6% between 2013 and 2014. Their %Δ Net Fixed Assets Turnover ratio had decreased by 2% in the past two years which means Microsoft has been less effective in making investments to generate revenue. Microsoft’s Total Debt to Equity ratio had also increased from a %Δ of .18% between 2011 and 2012 to .20% between 2012 and 2013 to .25% between 2013 and 2014. Their %Δ Total Debt to Equity increased by .7% in the last two years which means Microsoft is taking substantially more debt as well. When I evaluated Microsoft’s Fiscal Year percentage changes last summer, I had expected their financial performance to decrease but not this soon.
When I had projected Microsoft’s Pro Forma 5 year Future Forecasting, I had projected a 0% growth for the first two years and a 5% decrease for the remaining three years for the 5 year forecast in Sales, Accounts Receivable, Assets, and Liabilities Growth rates respectively. This time however, I’m projecting a theoretical 5% decrease for the first two years, a 0% growth rate in the third year and a 5% increase in the remaining two years to simulate what would occur if Satya Nadella’s restructuring is proven successful over time. The following Forecasting would result in a %Δ of 15% growth in Free Cash Flow between the plateau at 0% growth rate to the 5th year of the Future Forecasting. This would result in a 7.56% Weighted Average Cost of Capital, and a Per-Share Equity Value of $49.26 which today’s Per-Share Equity Value is $44.5; that’s an increase of $4.76 over the next 5 years if Microsoft’s growth is gradual. In retrospect, I agree with majority of the investors who advise to sell Microsoft’s stock and at that note, we’ll close off in talks of Capital Structuring.
In context of Capital Structuring, Microsoft has especially been an unstable company in terms of financial performance in contrast to Apple. Apple doesn’t incur debt as they primarily leverage equity, as long as Tim Cook can maintain profitability Apple will never go bankrupt as they have an abundance of retained earnings. Microsoft on the other hand is for the most part in the middle, leveraging both equity and debt which allows them more tax write offs for utilizing credit. But in the terms of long term horizon and maintaining a foothold in today’s market, Apple is in a better position regardless if Microsoft still holds majority share of the desktop and enterprise market. Many Financial Managers will argue whether a company should leverage Debt, Equity, or both in their Capital Structure; but the answer is neither. Capital Structure depends on the company and its industry, the technology industry constantly weeds out competition so remaining in business is ultimately the name of the game when it comes to technology. Apple has had an arguably stagnant role in today’s market’s innovation, albeit they’re doing financially well which means that they still have the means to make a comeback; but if Microsoft hits rock bottom they’re doomed. Microsoft bailed Apple out from bankruptcy when Steve Jobs returned as CEO, but given Microsoft’s popularity I don’t believe anyone will bail them out. Satya Nadella has Bill Gates for now, but the future of Microsoft ultimately relies in Nadella’s hand. Growing up using PC’s and wanting to make the switch to the Windows Phone, I hope Nadella succeeds…
If you enjoyed this Corporate Finance series, please leave a like at the top of the article and I’ll do my best to do so again for other topics. But if you’d like me to cover Apple, Google or someone else’s Forecasting and Valuation sound off in the comments below.
Image:http://blogs.microsoft.com/wp-content/uploads/2012/08/8867.Microsoft_5F00_Logo_2D00_for_2D00_screen.jpg
