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Microsoft - A Compelling Trade

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All Things D reported earlier this week that Microsoft (MSFT) is considering a restructuring program that could reduce the number of operating divisions at the tech giant to four, from eight currently. Late last year, the company announced plans to s shift its focus to devices and services, including internet-based products, the Surface and Xbox, and away from the Windows platform.

The management suite has seen a bit of a shake-up recently, with the departure of CFO Peter Klein which was announced in April and the announcement this week that CIO Tony Scott will be leaving. There is speculation that Satya Nadella, head of the server business, Don Mattrick, who runs Xbox, and Tony Bates, president of Skype will have more prominent roles in the executive suite going forward.

In April, activist investor ValueAct Holdings LP disclosed a stake of about $2 billion in MSFT (less than 1% of the shares outstanding). ValueAct has been known for seeking board seats or asking for other changes at companies in which it invests in the past. While its small stake may not lead to any activism as some may hope, ValeAct does believe the company is undervalued by other investors.

Since reporting fiscal third quarter earnings on April 18th, the stock has popped more than 20%. This move has accounted for most of its greater than 30% move year-to-date. However, MSFT still has a cheap valuation. It trades at an 11.5x forward P/E, a discount to its ten year average of 14x, and to the S&P 500 which is currently trading at 14.9x.

When you take into consideration the potential reorganization mentioned above, catalysts such as the momentum in the cloud space, the seasonally stronger second half demand for technology products (and subsequent stock rally), the Windows 8.1 release, and the company's cash flow position, it's easy to see how this stock could continue to move higher into year end. At the end of the third quarter MSFT had nearly $9 per share in cash on the balance sheet and offered a 2.5% dividend yield. The dividend is expected to be boosted in September, which should drive the yield back to 3%.

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