What Warren Buffett Can Teach Microsoft

In the very early cash-strapped days of Microsoft (MSFT - commentary - Cramer's Take), Bill Gates made a resolution that he'd get the company to the point that it always had enough cash to run for a year, even if it never received a dime from anyone.

Today, with annual expenses of $20 billion and cash and investments of $54 billion, Microsoft can theoretically operate with zero revenue for nearly three years. Are the dividend mongers right in putting pressure on the company to pay out all the excess cash to shareholders? Alternately, shouldn't they spend at least $30-odd billion on a large stock buyback?

Contrary to popular opinion, Microsoft is a fragile business. While the company has a wide range of products and services ranging from Hotmail to MSNBC to Xbox, more than 68% of revenue and 107% of operating profit come from just two product families -- Windows and Office.

Without them, the company wouldn't be making a dime, even with the $10 billion in revenue the other products bring in. Windows and Office need upgrades to make money, and upgrades are only compelling with revolutionary improvements. DOS to Windows was revolutionary. Office 2000 to Office XP is ho-hum.

Windows Server, SQL Server, MSN, Hotmail, Expedia, Xbox, Microsoft Press, Microsoft Consulting, Great Plains, bCentral, Pocket PC and Windows CE are all terrific well-positioned Microsoft offerings. Many are market leaders. Yet, in aggregate, they drain about a billion a year from the company's coffers.

Depends on Upgrades

One might argue that Windows and Office are so ubiquitous in our everyday lives that, by themselves, they make the Microsoft business-model bulletproof. Well, not quite.

The problem for Microsoft in developed markets like the U.S. is that unit growth in PCs is anemic. The heady days when the installed base of PCs posted double-digit gains every year are behind us, and Microsoft is heavily dependent on upgrades. Without the upgrade revenue, both Windows and Office revenue would shrink dramatically.

---

Mohnish Pabrai is the managing partner of Pabrai Investment Funds, an Illinois-based value-centric group of investment funds. At time of publication, Pabrai was long Berkshire Hathaway, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. He appreciates your feedback at [e-mail]. You can access his Web site at www.pabraifunds.com.