August 25, 2013 5:44 pm

Ballmer resignation unlikely to quell unease over Microsoft

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Steve Ballmer©Reuters

Last week’s pre-emptive announcement by Steve Ballmer that he is to step down as chief executive of Microsoft looks set to defuse some of the growing shareholder unhappiness about leadership at the software company, according to analysts.

But it is unlikely to guarantee either the company or its chief executive a smoother ride. With Wall Street still unsure about the company’s direction and an activist investor pushing behind the scenes for more shareholder-friendly action, Microsoft faces a critical period over the next two months that could determine the fate of the new “services and devices” strategy that Mr Ballmer has tried to set for it.

Discontent among Microsoft shareholders has hit an all-time high, says Rick Sherlund, a software analyst at Nomura Securities, as Wall Street worries that the company has still not come up with an adequate response to the waning demand for PCs.

Mr Ballmer himself has been a frequent target of the unhappiness in recent years. While activists such as hedge fund manager David Einhorn have at times called openly for his dismissal, other influential shareholders have preferred to work behind the scenes, taking their concerns directly to Microsoft’s directors, according to people familiar with some of the approaches.

The pressure on Mr Ballmer mounted again this year as ValueAct Capital Management, an activist shareholder, took a sizeable stake.

Two events over the past six weeks have added to the tension with Wall Street. Mr Ballmer’s announcement of an extensive organisational shake-up in July drew cautious applause, but left many questions unanswered – chief among them how much Microsoft will spend as it tries to expand in mobile devices and internet services. Promises of answers at a financial analysts meeting on September 19 have done nothing to quell the impatience.

That was followed within days by the news that Microsoft’s business had deteriorated even more than expected in recent months. The earnings provided the first evidence of how deeply this year’s slump in PC sales has eaten into its core Windows business, analysts at Barclays said at the time.

Some on Wall Street credit Mr Ballmer with having already responded to the rising unease among investors. The appointment of Amy Hood as new chief financial officer has been greeted as one sign that the company wants to rebuild relations.

“They are listening more to what shareholders want and are willing to give more data points to understand the company than they have for a while,” says Brent Thill, a software analyst at UBS.

After the poor response to the new Windows 8, a reboot with Windows 8.1, due to hit the market in mid-October, has also stirred moderate optimism, as have signs that new online services such as Office 365 are starting to gain momentum.

“All the pieces are being put in place,” Mr Thill said.

Central to Wall Street’s abiding unrest, however, are how the strategy will play out in detail, and what it will mean to Microsoft’s deployment of its vast financial wealth.

Nine years ago, sitting on $60bn of cash, Microsoft seemed to embark on a new, shareholder-friendly phase as it paid a one-off dividend of $32bn and ramped up its share buybacks. The share buybacks have slipped back as the outlook for its business has deteriorated. However, over the past three years, Microsoft’s net cash position has doubled to $62bn.

One source of anxiety for Wall Street has been how much of the mounting riches will get diverted into paying for the infrastructure needed to support the cloud services the company sees as its future. Shareholders are still also nervous about big investments in recent years that have yielded little, such as the $17bn Mr Sherlund at Nomura estimates Microsoft has spent on trying to match Google in internet search.

The mountain of cash has also attracted the interest of activists, who would rather see more cash returned to shareholders in the short term. Some $70bn of Microsoft’s gross cash of $77bn is overseas, leaving it facing a big tax bill if it wanted to bring the money back to the US. But it could follow the recent example set by Apple and borrow against its cash. That could support the buyback of as much as 20 per cent of the company’s shares and drive the stock price above $40, says Mr Sherlund – a level it hasn’t touched since the collapse of the tech bubble in 2000.

“Right now, Wall Street is very confused about what this company looks like – they need a multi-year plan,” says Mr Thill of UBS. “All these things can account for a shareholder-friendly outcome.”

To reach that happy outcome, Mr Ballmer will have to do a better job in the coming weeks of laying out what Microsoft stands for – and when his shareholders will see the benefit.

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