Marcial: Microsoft, Google Good Bets
Whether Microsoft gets Yahoo or not, some investing pros see money to be made long-term on the kings of software and search
With Microsoft (MSFT), Google (GOOG), and Yahoo! (YHOO) ensnared in troika-like machinations, how should investors approach this intriguing triangle? Some of the smart-money pros think this unprecedented battle of the tech titans could produce solid returns for their portfolios, if played adroitly.
Microsoft’s hostile $44.6 billion bid to gobble up Yahoo has forced Google to engage the software giant in a battle to protect its turf in search. (The deal’s current value is $41.5 billion, based on a drop in Microsoft shares since the Feb. 1 announcement.) Regulatory issues would stymie any attempt by Google, the No. 1 Internet search engine, to launch a rival bid. Nonetheless, Google is determined to stop any Microsoft-Yahoo deal, and one way to accomplish that is to convince Yahoo to form an alliance in Web search. Yahoo is No. 2 in that lucrative business.
Yahoo’s stock skyrocketed from $19 a share to $28 after Microsoft unveiled its not-too-unexpected designs. Microsoft’s cash-and-stock offer is equivalent to $31 a share, So unless you are a nimble trader, forget about chasing Yahoo. The big money has been made. The risks in pursuing Yahoo stock at this high level should scare anybody who isn’t a prescient, professional, swift-footed trader.
But there is a way to win from the Microsoft-Yahoo-Google triangle. First, assume that Microsoft will play a hard-knuckle brawl and won’t let Google get in its way. Assume, as well, that ultimately Microsoft will have its way with Yahoo, perhaps paying a few billion more for the embrace.
Things Could Get Ugly
Yahoo will, of course, attempt to delay any deal as part of a strategy to persuade Microsoft to up the ante. Microsoft might just do that, up to a point. But since it doesn’t look like there are eager white knights waiting in the wings—because the deal is mighty expensive as it is—Microsoft may not be inclined to be too generous with its offer. And who, aside from Google, has the resources and capability to pursue Yahoo at this high price and expect to benefit from the chase?
Yahoo may want to outsource part or all of its search-engine business to Google and others. That, of course, would be anathema to Microsoft, which could drop the entire offer. In that case, Yahoo’s stock would crash and leave its shareholders in limbo. At best, Microsoft will fight like an enraged rejected suitor to get what it wants. That could get ugly. And Yahoo would see its chances vanish of providing shareholders with the value they deserve. Nobody can guarantee, or even imagine, that Yahoo’s stock price will get to the level it is today without a deal like the one that Microsoft is offering. Yahoo shareholders have been waiting patiently for a turnaround. The Internet bubble burst in 2000, and the tech bulls have left Yahoo’s playroom.
So what should investors do? You can’t go wrong at this point if you buy shares of both Microsoft, now trading at $28—off from $37 in November, 2007, and way down from its high of $59 in 2000—and Google, currently at $505, down from its high of $747 on Nov. 7, 2007.
An Underappreciated Microsoft
Why buy Microsoft and Google now? Both are down from their highs and are looking very attractive as long-term holdings based on their prospects for solid growth. One big investor who has been upping his stake in Microsoft and Google is Martin Sass, chairman and CEO of M.D. Sass, an investment management company that shepherds $10 billion. Sass first purchased Microsoft shares in May, 2007, at $28 a share, and Google when the stock was at $365. Sass considers Microsoft a “value” play and Google a “growth” stock.
Microsoft has long been underappreciated by the Street and by investors. Sass figures the stock, currently trading at a price-earnings ratio of 14, is cheap based on the company’s expectations of yearly double-digit growth in 2008 and 2009. Revenue growth is projected at 14% to 18% over the next two years, says Sass. In the current difficult economic times, Microsoft and Google are both doing fairly well, he adds.
Microsoft should continue to gain market share in software, generating 60% of its revenues in foreign markets. Excluding any deal with Yahoo, Sass expects Microsoft stock to hit $40 in a year. Should Microsoft bag Yahoo, that would be a big positive for Microsoft shares, says Sass. Some analysts worry that the potential integration challenges in buying Yahoo could generate headaches for Microsoft, in part because of a dilution in earnings. But they agree that the hostile bid for Yahoo makes strategic sense to jump-start Microsoft’s online presence with consumers, advertisers, and publishers. It would enable the software giant to “better monetize its online assets over time,” says Brad Reback of Oppenheimer (OPY).
One of the bulls on Microsoft is Jim Yin of Standard & Poor’s (MHP), who hoisted a strong buy recommendation based on the fundamentals even before the offer to acquire Yahoo. His positive rating is based on his expectation of higher sales of PC units from the launch of Windows Vista and the stock’s relatively low valuation. His 12-month target for Microsoft (without Yahoo) is $43 a share.
Mark Murphy, managing director at Broadpoint Capital, who recommends buying Microsoft shares, supports its move to acquire Yahoo. The deal would change the global Internet search and advertising landscape so that it would essentially comprise just two major players. “A fragmented market would become a duopoly overnight,” says Murphy. With Yahoo, Microsoft would gain enhanced engineering talent to drive innovation, he adds. Internet advertising depends upon scale and requires massive capital investments to build a global platform, and Microsoft could add to Yahoo’s strength.
Google: An Opportunity as Well
And why buy Google? Even with a combined Microsoft-Yahoo to confront, Google will continue to have an edge in the search business, with a 75% share of the global paid-search market and 65% of the U.S. paid-search business. In Europe, Google’s advantage is even bigger, with its 85% slice of the pie. “Google remains a very attractive long-term growth stock,” says Sass, who forecasts earnings of $19 a share in 2008 and $23 in 2009, vs. 2007’s $11.78.
Rob Sanderson of American Technology Research, who rates Google a buy, believes strongly that Google has several years of “exceptional growth ahead.” With the stock’s slide after some investors bailed out following disappointment with the recent quarterly earnings, and Microsoft’s bid for Yahoo, Google represents a buying opportunity, argues Sanderson. Neither event changes the opportunity for Google to grow strongly for a number of years, he adds. His 12-month target for Google: $750.
Any time a value play like Microsoft and a growth stock like Google weaken in price, the opportunity to buy them should be considered a gift, especially if you are a long-term investor. With or without a Microsoft-Yahoo combination, both Microsoft and Google will be considerable winners in the years ahead. Of course, with Yahoo, Microsoft will be a more challenging rival for Google. That in turn will undoubtedly push Google to move aggressively to widen its lead over the Microsoft-Yahoo combo. Who would end up the loser? Investors who fail to buy into Microsoft and Google now.
Marcial writes the Inside Wall Street column for BusinessWeek.