* Stock is "insanely cheap" says one investor
* Trades at 10 times expected 12-month profit, below peers
* Suffers perception gap with Apple
* Concerns over response to iPad
* Value momentum in stock very high
(For other stories in this series on hedge fund activity in
the second quarter, click on [ID:nN30171955])
By Bill Rigby
SEATTLE, Aug 30 Top hedge fund managers like
Dinakar Singh and David Einhorn scooped up Microsoft Corp
(MSFT.O) shares in the second quarter, taking advantage of
historically low price-to-earnings multiples for the world's
largest software company.
Microsoft -- whose systems run more than 90 percent of the
world's personal computers -- saw its shares fall sharply last
quarter, even as Wall Street analysts forecast rising profits
in the year ahead.
The decline means the stock is now trading around 10 times
expected earnings for the next 12 months, close to its lowest
multiple on record and a 70 percent discount to peers,
according to StarMine data. And taking into account Microsoft's
$37 billion of cash, the true multiple is more like 8, some
"That's insanely cheap for a company of this caliber and
market position," said Whitney Tilson, managing partner of T2
Partners LLC and the Tilson Mutual Funds, who bought Microsoft
shares in the second quarter.
While most investors seem to have concluded that the growth
days of the stock are over, a growing faction of savvy hedge
funds -- including Singh's TPG Axon, Einhorn's Greenlight
Capital, John Griffin's Blue Ridge and Thomas Claugus's GMT
Capital -- see an undervalued opportunity in the huge and
increasing profits delivered by the Windows 7 operating system
and Office franchise.
Interest from such fund managers helped make Microsoft one
of the largest additions in the second quarter Smart Money
survey, compiled by Thomson Reuters, of the portfolios of 30 of
the biggest fundamentally-oriented hedge funds.
(For a chart showing Microsoft's P/E ratio relative to its
peers, and comparing net profit to its share price, see
THE APPLE PROBLEM
The Redmond, Washington-based company took a hit to its
prestige in May when old rival Apple Inc (AAPL.O) surged past
it in market value. [ID:nLDE64Q0CG]
Apple is much less profitable than Microsoft, but it is
rewarded with a higher multiple by investors excited by a
stream of innovative products like the iPhone and iPad.
A lot of Microsoft's value is overlooked in comparison,
said Patrick Becker Jr at Becker Capital Management, also a
holder of the stock.
"It's a perception issue with them (Microsoft). For
whatever reason, if you do well with the consumer, you get a
higher multiple on your stock," he said. "Microsoft doesn't get
very much credit for what they do on the business side and the
dominant share they have there."
But some Microsoft problems are more than perception.
Despite its seemingly unassailable dominance in the business
software sector, some investors worry the company has no
response to the iPad, which threatens to wean consumers off
netbooks and may work its way into corporate life.
Its new phone software -- due to debut in the next few
months -- needs to make up a lot of lost ground, and its
money-losing Bing search engine has not made any great inroads
on Google (GOOG.O).
The stock is suffering under the weight of those doubts,
some investors say, falling 21 percent in the second quarter,
compared to a 12 percent fall in the Standard & Poor's 500
index. Some hedge funds, including Appaloosa Management,
Chilton Investment Co and Pennant Capital Management, took the
opportunity to trim their holdings in Microsoft last quarter.
"Tablets -- the iPad in particular -- and the smartphone
market are major overhangs and discounted heavily in the
stock," said Ken Allen at Baltimore-based portfolio manager T.
Rowe Price, whose Science and Technology Fund has Microsoft as
a major holding.
MORE VALUE, LESS GROWTH
The consensus view appears to be that Microsoft is now more
of a value investment than a growth opportunity. The company
has played its part in that, introducing a dividend in 2003 and
paying a special dividend of $3 per share the following year.
It is expected to increase its quarterly dividend next month
from the 13 cents per share it has paid out for the last eight
"There's a record of them returning excess cash to
shareholders," said Becker. "I don't think you'll see a special
(dividend) out of them, but they will continue to raise the
regular dividend and do share buybacks."
Microsoft's value momentum -- which can signal that a stock
may soon revert to historical valuation levels -- is now
greater than 83 percent of U.S. companies, according to
StarMine data. That view is shared by some investors.
"The stock is unsustainably cheap here," said Allen at T.
Rowe Price. "Their medium-term growth outlook is really strong.
The market is saying the company's growth phase is over and it
has these secular concerns. I'm saying the growth phase is
continuing and I feel better than the market does about their
Others are betting only that Microsoft is a winner in the
"Google Apps and other competitive threats may well come
true -- we're simply betting that they don't come true in the
next six to 18 months," said Tilson. "There are a lot of
big-cap blue chips that are very cheap, and we own a number of
them. But this one is particularly compelling."
(Reporting by Bill Rigby; editing by Aaron Pressman and John
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