An Update on the Relative Value of IBM v. Microsoft

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An Update on the Relative Value of IBM v. Microsoft

As I mentioned this past September, IBM passed Microsoft in market capitalization. In other words, the financial markets assigned a greater total enterprise value to IBM than to Microsoft, based on the stock price multiplied by the total number of shares outstanding for each company. Stock prices are quite volatile, but it's interesting to see that the gap has widened. At the close of trading yesterday, Microsoft had a total market capitalization of $215.35 billion, while IBM's market capitalization was $228.71 billion. Translated into percentages, IBM is more than 6% more valuable than Microsoft.

Market capitalization represents the stock market's assessment of a publicly traded company's value, at least for the part of the company that's publicly traded. (Some companies are privately held with only a relatively small amount of stock publicly traded, but that's not the case here.) That value is, in turn, based on the market's assessment of the net present value of the company's earnings. The higher the expected profit (and profit growth), the higher the market capitalization should be, at least over the medium to long term. Therefore, at this moment, the stock market is betting that IBM has a brighter future in terms of profits than Microsoft, on a risk-adjusted basis.

What's particularly interesting to me in this comparison is that IBM's balance sheet, while extremely impressive, is rather different than Microsoft's. Microsoft has a bigger amount of cash (and cash equivalents) on its balance sheet. According to Yahoo! Finance Microsoft has over $42 billion in net cash, while IBM's total debt is actually greater than its cash balance. IBM's debt is a bit misleading because a good part of that is debt from its IT financing division, which is exactly what a financing division is supposed to do and which has no real equivalent at Microsoft. But there's practically zero valuation risk with cash on hand, meaning that the stock market should assign a lot of value to that cash. The stock market does, but it doesn't matter enough: IBM is the more valuable company. Said another way, the stock market doesn't seem to have much confidence that Microsoft knows how to leverage that cash hoard in profitable ways.

I'm compelled to agree, and the news this week reinforces my view. Consider that IBM is using some of its cash to buy Cúram Software. We don't know how much IBM is spending for Cúram, but a couple hundred million is a reasonable guess, perhaps even on the high side. Contrast that acquisition with Microsoft's $8.5 billion acquisition of Skype, which was completed less than two months ago. Is there anyone willing to argue that Microsoft's acquisition of Skype will be more than 42 times more beneficial (in terms of future profits) than IBM's acquisition of Cúram? I'm not willing to make that argument.

Meanwhile, Apple is still the world's most valuable publicly traded technology company with a market capitalization of $361.62 billion at yesterday's closing price. And with that statistic I'll conclude this blog post, written from my new MacBook Air, because my iPhone is ringing.

by Timothy Sipples December 8, 2011 in Financial


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