Microsoft - A Compelling Trade

Lindsey:

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%.

Jill:

One of my favorite spaces to be in is tech. The group has underperformed relative to the S&P, although the companies are focused on investing in growth, sport stellar balance sheets and represent very attractive valuations. For those of you that follow me, it has been a consistent theme in all of my content on OP and in the webinars and classes I teach. My key areas of focus are service/analytics, cloud, data storage and cyber security. During my webinar with Jon DRJ Najarian on Monday, I expressed that view with a synthetic call in the Technology Select Sector SPDR (XLK), which is something that Skip and I have traded in and out of several times. MSFT is one of the top 10 holdings of that ETF.

Recently, MSFT announced an acquisition of InCycle Software's release management solution business, which will strengthen MSFT's ALM and DevOps solutions with Release Management capabilities thus allowing customers to create and deliver applications at a much faster rate. Further, MSFT can enhance its developer offerings and create its own apps in the future. This clearly falls inline with my area of focus.

We have also seen some nice, bullish activity in the options market. In recent trading, an investor bought 6,200 January 40 calls for $0.60 when the stock was just under $36, expressing the expectation of a robust rally into year's end. If this bullish call activity is correct, shares have a nice opportunity to rise on a relatively cheap play, as vol is an attractive bet on this trade.

I would piggy back on this trade because it represents a nice risk/reward scenario. Keep in mind that you can lose 100% of the premium and entry and exit points are always contingent on your trading plan and capital availability. I typically trade spreads for the 100%, risk-controlled profile, but I think this is an attractive bet based on sound fundamentals, a solid balance sheet and my bullish bias on the sector. We can get involved just $0.02 above the price an institutional buyer got in that I mentioned above.

Trade: Buy to open MSFT Jan 40 calls for $0.62.

If you have any questions or feedback, please use the comments section below to reach out to Lindsey and I. Trade Well.

OptionsProfits can be followed on Twitter at twitter.com/OptionsProfits.

Lindsey can be followed on Twitter at twitter.com/lindseycbell

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