Microsoft: What Wall Street is Overlooking, Part 2

Bill Koefoed, Microsoft GM of Investor Relations, talks about what he believes investors are missing in their analysis of the company.
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This is the final installment of TheStreet's interview with Bill Koefoed, Microsoft GM of Investor Relations. Click here to read Part 1.

Eric Jackson: How are you going to play in social -- just through your investment in Facebook?

Bill Koefoed:

There are a bunch of ways that we are driving social experiences across our platforms, products and services. Xbox Live and Windows Live are obvious ones; we are doing some very interesting things with Facebook through Bing, and that will be a place to watch. We are also bringing social into our collaboration offerings, including Office 2010, and it will be a space to watch moving forward.

Why doesn't Steve sit in on the earnings calls with Peter? Jobs and Schmidt don't, but Bartz and Balsillie do. Why not Steve?

Steve participates in a large number of externally-facing events, such as the Windows Phone 7 launch. He delegates the investor-related activities to Peter and myself as we have the best day-to-day interaction with investors, view to the numbers and the questions that investors are asking. He obviously participates in our financial analyst meeting and meets with investors from time to time.

What do you think is the biggest misconception of Microsoft (MSFT) - Get Report among investors and analysts? Who is responsible for that misunderstanding?

We are in a lot of businesses, and a lot of markets. Some of the places we are investing in today like cloud, search and mobile are emerging and critical to long-term growth. Others, such as Windows and Office have competitors, but we continue to innovate and drive increasing value to customers.

Since 2001, Microsoft has grown revenue from $25.3 billion to $62.5 billion in 2010, a CAGR of 11%. EPS has grown from $.66 to $2.1, a CAGR of 14%. Our Server and Tools business has grown to be a $15 billion business. We've grown new billion-dollar businesses: Xbox (+ Xbox Live), SQL Server, System Center, Unified Communications (Exchange), SharePoint, Developer Tools (Visual Studio), Dynamics (ERP & CRM), Online Advertising (display & search). I think that people lose sight of our ability to grow and scale.

Do you think there are any big misconceptions about your competitors in different spaces?

Google

(GOOG) - Get Report

has been making lots of claims when it comes to cloud computing, while businesses are continuing to buy Microsoft. Today, more than 40 million people are using Microsoft Online Services, which are available in 41 countries and regions around the world. We are tapping 20 years of productivity experience while they (Google) tap advertising experience. If you look at the traction Google has claimed - they are now backtracking. Customers and educational institutions recognize they are not prepared for business needs.

A lot of investors are still scared by the whole Yahoo! (YHOO) hostile bid foray. They're concerned that you guys are not sure of yourself. You wanted to do the deal, then you didn't (thank goodness for investors). The concern going forward is: How are you going to look at M&A now? You haven't done any deals this year while Google has done a bunch. Is that indicative of what we can expect going forward?

We feel like we have the right partnership in place with Yahoo! that will help us gain the scale and relevancy needed to drive success in our search business. This combination now makes up for almost 30% of the U.S. search market. Not all of our acquisitions are made public, and that goes for most companies. Our philosophy on M&A has not changed; most often we look to do small acquisitions that complement our organic growth -- tuck-in acquisitions. Talent is the most important part of any deal.

Google appears to be searching out a number of revenue opportunities beyond their (only profitable) search business.

Your annual R&D budget -- compared to most other companies -- is massive. Yet most casual investors think of some of your competitors as being much more innovative. So, what are we missing? Have your R&D efforts been too theoretical, have they been poorly managed, or are you expecting some massive payoff soon from the 10+ years of work?

As a percentage of revenue, we've been pretty consistent on our R&D spend over the years. Most of our R&D spend is on improvements to our current products, while some is spent on new products and has created those billion-dollar businesses that I mentioned above and hopefully the next generation of billion-dollar businesses. Note that we look at our ROIC, which is the leader among technology companies.

Can you help us understand how much of your cash is sitting offshore, why you can't touch it, and what you're going to do with it?

We've stated that more than 50% of our cash sits offshore. As we stated in our 10k, if we repatriated the offshore cash under current U.S. tax regulations, it would result in a multibillion-dollar tax burden. We use offshore cash for offshore investments and general corporate purposes.

One of your most important shareholder groups is your employees. We sometimes hear rumors about grumblings from the workforce over the stock price. What would you say to that group?

Our employees are pretty excited about the product momentum under way. In the past 12 months, we've launched new products and are seeing customer momentum in every business group. Our employees first and foremost want to see customer adoption, satisfaction and share momentum; they know we have tough competitors in the market and they are committed to deliver great products. Over the long run, the share price always is a reflection of earnings.

You just raised your dividend, raised some debt, and promised more buybacks. In my view, it wasn't nearly big enough a dividend and debt raise. What do you have to say to investors like me?

The higher dividend, combined with our ongoing share repurchase program, reflects our commitment to returning capital to our shareholders and our confidence in the long-term growth of the company. Throughout the last ten years (ending June 30, 2010) Microsoft had returned nearly $170 billion to shareholders through dividends and share repurchases, which is very strong relative to any benchmark.

What kind of company is Microsoft going to be in 10 years?

Throughout the history of the computing industry, we have seen long stretches of steady incremental improvement, punctuated by waves of intense transformation and change. Key breakthroughs -- the microprocessor in the 1970s, the graphical user interface in the 1980s, and the Internet in the 1990s -- revolutionized the role that information technology plays in how we manage information, run our businesses and share experiences, bringing dramatic positive change to the lives of hundreds of millions of people.

Today, with the emergence of cloud computing, we're in the midst of the next great wave of transformation and change.

The cloud is revolutionizing computing by linking the computing devices people have at hand to the processing and storage capacity of massive datacenters, transforming computing from a constrained resource into a nearly limitless platform for connecting people to the information they need, no matter where they are or what they are doing. This has profound implications for the way people use technology across their lives to work, learn, communicate, and have fun.

With our unique position in the industry, it's not enough just to ride this great wave -- we intend to grow it and shape it. This is why we've made a company-wide commitment to Microsoft's solutions, bringing the benefits of the cloud to the billion people who use computing today and the billions more who will gain access to digital technology for the first time in the years ahead.

In fiscal 2010, Microsoft invested $8.7 billion in research and development, with most of that devoted to cloud technologies. Today, roughly 70 percent of Microsoft's 40,000 engineers work on cloud-related products and services, and in fiscal 2011 that number will grow to nearly 90 percent.

With the first version of Hotmail, Microsoft started investing in cloud computing more than 15 years ago. Today, our consumer cloud technologies and services support hundreds of millions of customers around the globe. More than 300 million people use Windows Live Hotmail and Windows Live Messenger to send nearly 10 billion messages every day. This year, our Xbox LIVE subscription base surpassed 25 million subscribers, a growth of over 20 percent from last year.

On the business side, not only are we offering online versions of our products, such as Microsoft Dynamics CRM Online, Microsoft Office 2010, SharePoint Online, Exchange Online and Office Communications Online, but we are delivering entirely new cloud computing platform innovations such as Windows Azure, SQL Azure and Windows Intune. The Windows Azure Platform Appliance is a groundbreaking product that will enable service providers, large enterprises and governments to achieve breakthrough datacenter efficiency through innovative power, cooling and automation technologies.

Currently, more than 10,000 corporate customers have adopted Windows Azure and thousands of business and government entities representing millions of people have purchased Microsoft's online productivity services to improve productivity and reduce costs. Customers include 13 of the top 20 global telecom firms, 15 of the top 20 global banks and 16 of the top 20 global pharmaceutical companies. Together, these technologies, products, and services enable us to do something no other company can do -- deliver cloud solutions that span the complete range of business needs our customers have.

At Microsoft, we firmly believe the impact of cloud computing will be as big as -- or bigger than -- the previous waves of technology change. The opportunities cloud computing will create for our customers, partners and our company will be immense.

At the time of publication, Jackson held long positions in MSFT and GOOG.

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Eric Jackson is founder and Managing Member of Ironfire Capital and the general partner and investment manager of Ironfire Capital US Fund LP and Ironfire Capital International Fund, Ltd. In January 2007, Jackson started the world's first Internet-based campaign to increase shareholder value at Yahoo!, leading to a change in CEOs in 2007. He also spoke out in favor of Yahoo!'s accepting Microsoft's buyout offer in 2008. Global Proxy Watch named Jackson as one of its 10 "Stars" who positively influenced international corporate governance and shareowner value in 2007.

Prior to founding Ironfire Capital, Jackson was President and CEO of Jackson Leadership Systems, Inc., a leadership, strategy, and governance consulting firm. He completed his Ph.D. in the Management Department at the Columbia University Graduate School of Business in New York, with a specialization in Strategic Management and Corporate Governance, and holds a B.A. from McGill University.

He was previously Vice President of Strategy and Business Development at VoiceGenie Technologies, a software firm now owned by Alcatel-Lucent. In 2004, Jackson founded the Young Patrons' Circle at the Royal Ontario Museum in Toronto, which is now the second-largest social and philanthropic group of its kind in North America, raising $500,000 annually for the museum. You can follow Jackson on Twitter at www.twitter.com/ericjackson or @ericjackson.

You can contact Eric by emailing him at eric.jackson@thestreet.com.