Microsoft Corporation

Exchange: NASDAQ National Market

Ticker: MSFT
Action: SELL
eeee
ECB Capital LLC
Bu!Si"e E#uit $esearch $eport
%n&est'ent Analsis ! No&e'(er )* +,-,
%n&est Soft in Microsoft
Prepared by
ECB Capital LLC - Everett B. Antrim-Indart 1
Table of Contents
Page
Brief Overview...
....
Economic Analysis...
/
Economic Breadown...
0
Ind!stry Analysis...
..1
Comparative Company Analysis.
)
"ana#ement Assessment.
..-.
$et!rn Eval!ation.
.-/
Company %al!ation.
.-0
Analyst &epart!res......
..-)
ECB Capital LLC - Everett B. Antrim-Indart '
Concl!sion....
.-2
ECB Capital LLC - Everett B. Antrim-Indart (
Economic Analysis
)&P and Pop!lation C*an#e
ECB Capital LLC - Everett B. Antrim-Indart +
Economic Breakdown
,ince t*e recent economic recession- ., )&P *as been performin# poorly- re/ectin# an
overall sl!##is* economy and low cons!mer con0dence. As pro1ected above- )&P is
e2pected to #row at a steady 1.34 per year !ntil f!lly recoverin# and res!min# *ealt*ier
levels. 5*is low trend is s!pported by poor c!rrent economic indicators s!c* as an
in/ation rate of 1.1+4 and an !nemployment rate of 6.784. .ntil t*e !nemployment
rate improves and cons!mers *ave more cas* to spend- )&P will not f!lly recover to pre-
recession levels.
5*e ,9P :88 *as rebo!nded somew*at since t*e recession- b!t it *as not res!med its
earlier levels of near 1-788. 5*is indicates an overall maret weaness w*en compared
to pre-recession levels. Corporate pro0ts *ave e2perienced a f!ll recovery as companies
are res!min# normal operations since c!ttin# bac on spendin# and employment.
;owever- many companies contin!e to *oard cas* in anticipation of do!ble-dip
recession. .ntil companies open !p t*eir capital reserves- m!c* of t*e economy may
contin!e to la#.
<!antitative Easin# I left t*e e=ects of low corporate bond and #overnment bill yields.
5*e >ed recently proposed t*e idea of a second p*ase of ?!antitative easin#- nown as
<EII- in *opes of stim!latin#
a slow economy. 5*is is an
!n!s!al >ed mane!ver and
typically last resorts after
ot*er alternatives *ave
been e2*a!sted. 5*is
s*ows t*e desperation of
t*e >ed in r!nnin# o!t of
weapons wit* w*ic* to
combat recessionary
press!res. Beca!se <EI left
t*e economy wit* a federal
f!nds rate 1!st above 84-
t*ere is little more printin#
cas* and b!yin#
#overnment bonds can do- save instill some *esitation into cons!mers and b!sinesses.
@ields are e2pected to remain low for years to come as a res!lt of <EII.
ECB Capital LLC - Everett B. Antrim-Indart :
@ield ;istory and
Industry Analysis
"icrosoft is classi0ed as a software p!blis*er accordin# to t*e Aort* American Ind!stry
Classi0cation ,ystem. Competitors in t*is 0eld incl!de IB" and Oracle. >or p!rposes of
t*is report- )oo#le will also be considered a primary competitor d!e to overlappin#
interests in software p!blis*in# and pro#ram development. 5*e software p!blis*in#
ind!stry is comprised of a n!mber of companies carryin# o!t operations needed for
prod!ction and comp!ter software distrib!tion. 5*ese companies desi#n- develop- and
p!blis* comp!ter pro#rams. 5*is can encompass video#ame development- cell!lar
p*one software p!blis*in#- and 0rmware development. "a1or prod!cts incl!de system
software- applications- tec*nolo#y cons!ltin# services- comp!ter desi#n and
development- and comp!ter *ardware and software resale.
Beca!se t*e software maret evolves ?!icly- it is essential to pay attention to mer#ers
and alliances- strate#ic ac?!isitions- tec*nolo#ical improvements- and service
e2pansions in order to ade?!ately !nderstand t*e f!t!re of t*is volatile ind!stry. As
"icrosoft *as #rown t*ro!#*o!t t*e years- it *as s!=ered si#ni0cantly diminis*in#
ret!rns in core b!sinesses. ;owever- wit* an e2tensive command of reso!rces and
capital reserves- ac?!irin# smaller companies *as come easily to "icrosoft as it *as
#obbled !p peons in a race to diversify and e2pand. Aow t*at "icrosoft competitor Apple
*as almost completely dominated t*e mobile p*one and m!sic ind!stries B"icrosoft tried
to #o toe-to-toe wit* Apple by developin# t*e C!ne and failed miserablyD- "icrosoft
leaders !nderstand t*e need to ac?!ire in more dynamic ways. ,teve Ballmer of
"icrosoft *as e2pressed interest in ac?!irin# Adobe to #ain its foot*old in t*e mobile
application platform arena. If t*e deal is closed- "icrosoft co!ld mae rebo!nds in t*e
mobile maret.
Industry Structure
Life Cycle Stage Growth Regulation Level Light
Revenue Volatility Medium Technology Change High
Investment Requirements Low Barriers to Entry Medium
Industry Assistance Medium Industry Gloali!ation High
Concentration Level Medium Com"etition Level High
E&ata from IBI, Forld Ind!stry
ECB Capital LLC - Everett B. Antrim-Indart 7
$eports
5*e software ind!stry at lar#e remains in t*e #rowt* sta#e and as s!c* may be
!npredictable. Earnin#s and sales volatility is low medi!m in addition to *i#* levels of
competition and innovation. 5*e level of ind!stry #lobaliGation is *i#*. 5*is means t*at
t*e ., maret will become more sat!rated over time.
)overnment controls and re#!lations pose some concern for t*e software development
ind!stry. ,peci0cally- antitr!st claims *ave p!t "icrosoft !nder a ne#ative li#*t in recent
years. In '88:- "icrosoft a#reed to pay $ealAetwors a total of H378 million to drop
antitr!st claims. $ealAetwors alle#ed t*at "icrosoft !nfairly b!ilt Findows "edia Player
into its Findows IP operatin# system and did not #ive t*eir prod!ct- $ealPlayer-
opport!nities to compete. >!rt*ermore- in '88'- "icrosoft reac*ed a settlement wit* t*e
., #overnment to 0naliGe an antitr!st investi#ation t*at demanded t*at man!fact!rers
were to be allowed to incl!de competin# software wit* Findows. In '883- a E!ropean
co!rt !p*eld a +63 million E!ro 0ne t*at t*e E!ropean Commission imposed on
"icrosoft. "icrosoft c!rrently faces penalties t*at co!ld brin# t*e total amo!nt owed to
over 1 billion E!ros. 5*ese #overnment interventions *ave dama#ed t*e face of "icrosoft
and allow competitors to cons!me maret s*are. Anot*er concern to "icrosoft is t*e
loose #overnment controls over software piratin#. Estimates of *ow m!c* reven!e
"icrosoft loses d!e to pirates *ave been varied between H'88 million and more t*an H'
billion per year. .ntil t*e #overnment increases controls over t*e software piracy maret-
"icrosoft will be at ris of losin# even more reven!es.
O!tloo for demand for
prod!cts and services in t*e
software development sector
is positive. &espite an
aforementioned la##in#
economy- "icrosoft and
competitors can e2pect
*ealt*y levels of #rowt* at
ECB Capital LLC - Everett B. Antrim-Indart 3
rates close to pro1ected )&P #rowt*. Advances in semicond!ctor and
telecomm!nications tec*nolo#ies are creatin# new micromarets wit* t*e software
ind!stry every day. >aster comp!ter c*ips and internet networs allow developers to
ma2imiGe software capabilities and !ses. "icrosoft and competitors are developin#
platforms t*e net e=ect of w*ic* is t*at !sers can interact wit* software and comp!ters
on ever increasin#ly intimate levels.
Comparative Company Analysis
"icrosoft is a company t*at develops- man!fact!res- licenses- sells- and s!pports
software prod!cts. It o=ers system software- server software- application software-
development mod!les-
and internet software.
"icrosoft was fo!nded in
163: and is c!rrently
one of t*e worldJs
leadin# software
companies. Its b!siness
clients are "icrosoftJs
lar#est client base wit*
cons!mer clients as
second. 5*e
entertainment and
b!siness cons!mer
bases *ave proved to be
relatively stable in t*e
past two years- w*ile
online services *as fallen be*ind- leavin# a window for )oo#le to contin!e to win maret
s*are.

ECB Capital LLC - Everett B. Antrim-Indart K
1 @ear Competitor ,toc Prices
1 @ear ",>5 ,toc Price
ECB Capital LLC - Everett B. Antrim-Indart 6
: @ear ",>5 ,toc Price
"icrosoft e?!ities *ave performed at relatively stable levels. 5*is is consistent wit*
company *istory as a lar#e cap- bl!e c*ip stoc wit* relatively low reven!e /!ct!ation.
As an establis*ed- mat!re company in a #rowin# maret- one can e2pect contin!ed slow
#rowt*. &!rin# t*e economic recession- "icrosoft *as oscillated wit*in a ran#e of H'8
and H(8 per s*are. As a val!e investment- "icrosoft poses concern d!e to pro1ected
decreases in dividends- e2plained below- and less t*an p*enomenal #rowt* opport!nities
w*ic* !ltimately leads to a SELL ratin# as e2plained later in t*e report.
ECB Capital LLC - Everett B. Antrim-Indart 18
Below is a collection of #rap*s and c*arts for comparative !se.
ECB Capital LLC - Everett B. Antrim-Indart 11
ECB Capital LLC - Everett B. Antrim-Indart 1'
"icrosoft f!ndamentals are modest compared wit* primary competitors. "icrosoft s*are
pricin# *as decreased a total of +4 since '88+- s!##estin# t*at it may be a poor lon#
term investment. Conversely- "icrosoft c!rrently *as a low PLE ratio compared to
competitors w*ic* wo!ld s!##est t*at it is !nderval!ed. 5*is means t*at an investor can
b!y a piece of "icrosoftJs earnin#s for less t*an t*ose of "icrosoftJs competitors.
"icrosoft also *as *i#*er total sales and ret!rns on e?!ity t*an competition. A *i#*
ret!rn on assets indicates t*at "icrosoft !tiliGes assets in an eMcient and e=ective
manner. >inancially- "icrosoft proves itself to be a stable and stron# company s!pported
by a solid balance s*eet.
Management Assessment
ECB Capital LLC - Everett B. Antrim-Indart 1(
At t*e core of every company is
mana#ement. A stron#
mana#ement team can mae
all t*e di=erence for a 0rm and
"icrosoft seems to s!pport t*is
idea. "icrosoft *as a leaders*ip
team of (1 e2ec!tives amidst a
peer avera#e of 18. 5*is co!ld
indicate a bloated boardroom
too b!rea!cratic to mae
necessary and timely decisions.
;owever- on t*e !pside- t*e
avera#e ten!re of "icrosoft
e2ec!tives is nearly twice as
lon# as at peer companies. 5*is
indicates a dedicated mana#ement team- no small asset in a 0ercely competitive and
strate#ic environment. @et a#ain parado2ically- "icrosoft pays said mana#ement less
t*an peer avera#es.
Additionally- "icrosoft board members own 1'4 of s*ares o!tstandin# in comparison to
t*e K4 *eld by peer companiesJ board members. 5*is active interest e2empli0es
con0dence in t*e abilities of t*e e2ec!tive s!it and willin#ness to maintain said stae in
t*e company. All nine board members own staes in "icrosoft.
ECB Capital LLC - Everett B. Antrim-Indart 1+
Return Evaluation
Accordin# to re?!ired rate of ret!rn
assessments- "icrosoft *as a
re?!ired rate of ret!rn between
K.'+4 and 6.::4 !sin# CAP" and
>ama->renc* models. 5*is means t*at
an investor wo!ld re?!ire a rate of
ret!rn somew*ere in between t*ese
0#!res to 1!stify investment in
"icrosoft. "icrosoftJs ret!rn on e?!ity
is *i#*er t*an t*at of its competitors.
5*is meas!re is a meas!re of
pro0tability in comparison to peers. In
ot*er words- ret!rn on e?!ity meas!res rate of ret!rn on s*are*olderJs e?!ity of all t*e
common stoc *olders. It is a meas!rement of a 0rmJs ability to create pro0ts and instill
s*are*older val!e.
ECB Capital LLC - Everett B. Antrim-Indart 1:
Company aluation
&ividend "odel
Accordin# to t*is intrinsic val!e calc!lation- "icrosoft is si#ni0cantly overval!ed.
;owever- t*is model may not be completely acc!rate beca!se of t*e sewed dividend
#rowt* rates. Bloomber# analyst consens!s p!ts t*e #rowt* rates at 64 for t*ree years-
t*en -(14 for 0ve years. 5*is maes !sin# a dividend &C> somew*at diMc!lt. It is still
relevant beca!se if "icrosoft contin!es to decrease its dividend- its appeal to investors
s*o!ld be lower and t*erefore t*e low intrinsic val!e may be 1!sti0ed.
ECB Capital LLC - Everett B. Antrim-Indart 17
5*e information above depicts "icrosoft at an !nderval!ed position. Contrary to w*at
was stated !sin# a dividend &C>- t*is >C> &C> s!##ests t*at investin# in "icrosoft may
be bene0cial to a portfolio accordin# to cas* /ows. 5*e val!e was discovered by tain#
t*e present val!e of t*e >C> of "icrosoft- t*en calc!latin# P% >C> per o!tstandin# s*are.
5*at n!mber was t*en divided by t*e c!rrent price to >C> ratio. Beca!se t*e intrinsic
val!e calc!lations ret!rn contradictory n!mbers- one m!st be caref!l w*en !sin# t*em
for e?!ity val!ation and may be inconcl!sive.
ECB Capital LLC - Everett B. Antrim-Indart 13
5*is comparables set s*ows t*e 0nancial ratios and stat!s of "icrosoft in a broader pool
of ot*er competitors and similar companies. Beca!se t*ese companies are all not direct
competitors- comparisons may be somew*at sewed b!t still provide important
information. "icrosoft is t*e second lar#est of t*e above companies in terms of maret
cap. It *as a PLE ratio far below t*e comparable avera#e and a stron# one year EP,
#rowt*. 5*e company also *as above avera#e c!rrent ratio and ?!ic ratios meanin#
t*ey *ave t*e ability to pay o= s*ort term liabilities and meet ot*er s*ort term
obli#ations. ;owever- as t*e table s*ows- "icrosoft s*ares *ave performed poorly wit* a
ne#ative total ret!rn. In terms of a company as a w*ole- "icrosoft proves safety wit* a
very stron# set of 0nancials. .nfort!nately- e?!ity performance does not re/ect t*at. In
order to !nderstand t*is more t*oro!#*ly- it is necessary to loo at analyst
recommendations.
ECB Capital LLC - Everett B. Antrim-Indart 1K
Analyst !epartures
Analysts at ECB Capital are #enerally bearis* on lar#e- slow #rowt* 0rms s!c* as
"icrosoft. 5*is e?!ity report m!st be taen into consideration amon#st ot*er analyst
recommendations in
order to #rasp a f!ll
ill!stration of "icrosoft
as an investment
opport!nity. 5o t*e left is
an a##re#ate
s!mmation of e2ternal
analyst opinions on
"icrosoft. O!t of +'
analysts- 3'4 place a
B34 ratin# on "icrosoft
s*ares and 'K4 declare
a 56LD ratin#. F*at is
interestin# is t*at Gero
analysts s!rveyed
placed a SELL on t*e
s*ares. It is ass!med
t*at analysts are ratin#
"icrosoft based on t*e determination t*at it is a val!e stocN not a #rowt* stoc.
"icrosoft is not a #rowt* stoc beca!se it is a slow #rowin#- 0nancially sec!re company
t*at is in mat!re sta#es of b!siness development. 5*erefore- no e2treme #rowt* can be
predicted in t*e f!t!re of t*e company. ;owever- val!e stocs s!c* as t*is are !s!ally
favored for *i#* yieldin# dividends. C!rrently- "icrosoft dividends are yieldin# 1!st above
'4. Accordin# to analyst consens!s- t*at dividend will s*rin by over (84 in t*e ne2t
0ve years- #ivin# it a s!rprisin#ly small aforementioned intrinsic val!e. 5*ere is a clearly
analyst disa#reementN an overw*elmin# B34 recommendation is taen wit* a #rain of
salt on t*e ass!mption t*at dividends will s*rin in t*e f!t!re. If ECB Capital were to
incl!de itself in on t*is a##re#ate consens!s- t*ere wo!ld be one more SELL t*an t*ere
reads now.
ECB Capital LLC - Everett B. Antrim-Indart 16
Conclusion
In brief- "icrosoft is a company notably solid in its 0nancials. It *as a stron# balance
s*eet- *ealt*y ratios- and leads competitors in a variety of aspects. In li#*t of recent
macroeconomic interventions- "icrosoft is too bi# to fail. 5*erefore- as an investment-
"icrosoft can at best provide a wealt* s*elter in w*ic* to lod#e f!nds. B!t on t*e ot*er
*and- #rowt* prospects for t*e company are #rim as it falls be*ind an innovation c!rve
set by faster companies s!c* as Apple and )oo#le. Fit* AppleJs !ni?!e style and easily
identi0able line of comp!ter and mobile *ardware- Apple seems to be encroac*in# on
more of "icrosoftJs maret s*are *ere. On t*e ot*er *and- )oo#le is t*e !ndisp!ted
leader of internet tec*nolo#ies and application software development. "icrosoft e2ists in
a c!t-t*roat ind!stry in w*ic* t*e 0rm w*o loos forward far eno!#* wins by resettin#
t*e innovation c!rve even steeper. "icrosoft *as not p!s*ed t*is c!rve eno!#* in recent
years- and s*are price *as in t!rn re/ected t*is. If an investor is looin# for #rowt*-
"icrosoft is too mat!re to provide t*is. If an investor is looin# for val!e- *e or s*e
s*o!ld overloo "icrosoft in favor of s!perior val!es elsew*ere. >or t*ese reasons- ECB
Capital places a SELL ratin# on "icrosoft s*ares.
ECB Capital LLC - Everett B. Antrim-Indart '8
E&isclaimerO 5*e information in t*is report is not by any means a solicitation for sellin# or b!yin# of s*ares of "icrosoft
stoc or any ot*er e?!ity by ECB Capital or its aMliates. 5*e opinions in t*e report are of ECB Capital and intended to
inform clients wit*in t*e company and not o!tside investors. It is important for all investors to remember t*at people
can and do lose money investin# in e?!ities. 5*ese are risy marets.
ECB Capital LLC - Everett B. Antrim-Indart '1