Rethink 50 in rude health as IBM and Intel dominate top profit spot - Rethink Top 50

Rethink IT, March, 2004

One of the first things you can't help but notice when you finally lay out all the data from this month's reporting season (some 36 companies have reported their December quarter since our last issue), is just how incredibly overrated Microsoft looks on the current figures.

While the overall assessment of a supplier must be based on its viability and whether it is likely and able to deliver on its promises, the validity of its investment position is certainly part of that picture.

With growth in the last quarter of just 19% and a margin of 15%, there's nothing much wrong with Microsoft as a company, but is it worth 7.5 times last year's revenues, plus the cash it has in the bank? If you took this quarter's net income and multiply by four quarters, as we have done in the next column, is Microsoft worth 47 times a year's worth of revenue at this rate?

Even if you take the rust four quarters of Microsoft figures, the other three of which have all been better than this one, it would yield a historic multiple of 35 times earnings.

Why, then, is it valued so much higher than Intel?

Well funnily enough, if you do the same exercise for Intel, raking the net income from its last four quarters, it gives an historic PE of exactly the same, 35. So is it true that Intel's and Microsoft's fortunes are tied together to such a great extent?

Perhaps we are over reacting, bur the facts for the last quarter are that Intel made $600m more than Microsoft, and it achieved the magic 20:20 rule--a greater than 20% margin while growing faster than 20%. That's what the high flyers in the industry have done over the years, and the measure still applies.

The two companies are roughly the same size, but one is more profitable, is growing faster and has better margins than the other.

Intel is also entering many new markets successfully, including Wi-Pi, cellphones, digital TV chips, wireless broadband and flash memory, All markets where its success does not rely on Microsoft's operating system and mostly in markets where Microsoft is not succeeding.

This year Microsoft has re-entered the TV software market, brought out its new Media Player, put out Windows Server 2003, entered the set-top box market and at the same time tried to bash down the walls of the cellphone operating system sector. At the moment it can't really point to any one of these already being a success, although in the end, perhaps they will all be.

Certainly it has made inroads in the digital rights management market and it is doing well in all its traditional PC markets. But that's about it.

So why is Intel, and even IBM and even Nokia, not closer to it in value? Well, the truth is that both of those two companies have put on close to $20bn of value, which to IBM is just a 10% improvement, and to Nokia is more like a 26% hike during the past month.

So the market is waking up to these companies' value, bur not to the weakness of Microsoft.

It is hard, we appreciate, to think little of a behemoth that holds $51bn in cash and which has hardly ever lost a war it entered. But it won all of its wars on bundling, channel control and price cutting. It has never won a war based on product quality and it's in several of those right now, plus one price war it can't win, against Linux.

In IBM's case its last four quarters made almost as much profit as Microsoft, and that was on a revenue growing healthily at almost 10%, and yet if you base its multiple on the last four quarters it sits on a multiple of just 22.

Yet in uncertain times the captive base of IBM Global Services is always a fine anchor to hold down 50% of the company's revenues.

At the risk of going on about it, Microsoft is neither invincible nor currently performing and its valuation at the head of the technology table ranks closer to superstition than it does to business success.

Cisco continues its recovery, if it isn't a bit late to call it that. It upped its revenues by 14.5% and stretched its net income to $1.3bn to claim fifth place on the table, a margin of 24%, based on driving operating expenses down even further; strength in its traditional high end routing line with bookings up 100% over last year; and good growth in its Advanced Technologies sector--which includes storage, security, home networking, optical, wireless and IP telephony, and which expanded to become 15% of total revenues.

Looking further down the list, we can see why companies like Texas Instruments have suddenly become investment darlings too. Its revenues have jumped 29% and it has swung a half billion dollar loss into a half billion dollar profit year on year. All this has been achieved by focusing on digital signal processing chips and the sectors where they are most useful.

EMC has shown a similar turnaround, but its valuation as five times its revenue and 38 times a year's worth of this type of profit, is again a habit purchase based on former glory. Its revenues have grown 25% against this time last year, but this time last year no-one was buying its shares.