Disclaimer: Your capital is at risk. This is not investment advice.
ByteTree Market Health Update; Issue 110
Microsoft (MSFT) is one of the greatest success stories in the history of commerce as they brought super-normal profits to a new level. Before software, making money, I mean serious money, was much harder, and companies like Coca Cola were the envy of the world. Back then, investors thought selling branded, sugary water was as good as it got.
Software, and more recently the internet, makes a mockery of the old world of commerce, as each dollar of profit requires minimal effort. Not only that, tech lends itself to the subscription model that investors cherish, leading to exorbitant valuations. It is little wonder that investors have flocked to tech where the need for capital is light and the returns on it are so high.
MSFT has stood out because it has “done it twice”. First, it cleaned up with software in a box, and then managed to position itself for the internet. It’s an impressive record. The problem for MSFT is that all of their greatness is priced in, and we’ve been here before.
Between 2000 and 2009, MSFT shares fell by 75%, despite sales nearly trebling over the period. Back in 2000, the last time tech investors lost their minds, MSFT had a 2% free cash flow yield and was growing sales at 30% per annum. Now it has a 2.8% free cash flow yield and is forecast to grow at 14%. Incidentally, 14% is roughly the growth rate achieved the last time it fell 75% between 2000 to 2009.
The trouble with MSFT isn’t that it’s in trouble; it’s just overpriced, along with so many capital-light, high-return businesses these days. I depend on Microsoft Office and will probably continue to do so for many years, but probably not forever because everything eventually gets challenged.
You can tell that MSFT is worrying about long-term growth because they are in the desperate acquisition phase. The latest example is the bid for the gaming giant Activision Buzzard for $68 billion.
Yet the biggest risk is not operational but financial. MSFT is in second place in the S&P 500 and is heavily owned by defensive investors. That means not only do passive investors own it (during a passive investment bubble) but many active managers too, as it is seen to be defensive. It is easy to understand why, as it has been the poster child for investment. It has delivered steady growth with low volatility and even scores well on ESG. What’s not to like?
Bitcoin is the opposite of Microsoft
Bitcoin has no profits, so the free cash flow yield is zero. That would be equally true whether bitcoin was trading at $1 or $100,000, which means we can ignore it altogether. Bitcoin may be over or undervalued but for a completely different set of reasons. No cash flow doesn’t mean no value. If you disagree, ask gold or the ever-growing market in collectables.
Bitcoin has delivered massive growth in its network over the past decade, much more so than MSFT. This hasn’t been a steady 14% or even 30%. It has been more than 100%, just without the steady progression. Bitcoin’s growth has been lumpy as hell, with huge booms and busts, which comes with the territory. Most find this volatility uncomfortable, and it is easy to see why.
But that’s largely because the authorities do their utmost to discredit this new digital asset class because it scares them. Some of their fear is a genuine misunderstanding, believing it is little more than the latest repeat of tulip mania. Yet those who do understand recognise the true threat because bitcoin has the potential to back a new financial system. And the way things are going, sooner or later we’ll need one.
Bitcoin has also been persona non grata on ESG scores. It consumes more electricity than a small country, according to someone on the internet. That has led to bitcoin miners being chased out of places like China only to land in places like Texas, where seemingly anything goes. What’s more, they have been doing deals with the renewables industry ensuring healthy demand for baseload power. That’s what the ESG scores seem to miss. If you have surplus power, you don’t have to waste it. You can mine bitcoin, store the “financial energy” only to redeploy it elsewhere. Maybe the ESG score is wrong, and imagine the re-rating as this sinks in.
Then there’s inflation. Bitcoin and MSFT both have a limited supply, which maintains asset scarcity. Yet when you included buybacks, MSFT’s supply is shrinking, albeit at a decreasing rate which ought to give it the advantage. It doesn’t, because the shares are so expensive that billions of dollars of profits don’t buy many shares these days. The justification for buybacks adding shareholder value is blown out of the water at high prices.
The other inflation comes from fiat currencies, which have an unlimited supply. 2021 has seen inflation rise to levels last seen in the 1970s. Historically, rising inflation has put downward pressure on share prices, especially the fashionable tech/growth areas (see nifty fifty). In contrast, assets such as gold benefit from it as they are deemed to be monetary assets that offer protection. Bitcoin is seen as an alternative to gold and is likely to enjoy the macroeconomic tailwinds in a similar way.
I believe bitcoin will prove less risky than MSFT over the coming years because it is just getting going while MSFT will soon resemble a sprawling conglomerate. Within a decade, MSFT will be living off the cash flow courtesy of its legacy software business while wondering what to do next. It will be ex-growth, and its shares will have de-rated. In the meantime, crypto will have cemented itself in computing, having challenged every single business model and will keep on going until it wins.
Each bitcoin cycle has seen increasing innovation and wealth creation in the wider crypto space, yet bitcoin has remained the dominant asset throughout, which gives reassurance this will remain. Bitcoin has already fallen by 50% since November and may do a little more, but you can be sure it will bounce back and be much higher a decade from now. In contrast, MSFT’s fall is just beginning.
As for ownership, you’ll struggle to find an institutional portfolio on this planet that is yet to consider MSFT. Yet those same investors commanding the big money haven’t touched bitcoin. That doesn’t guarantee they will buy it, but it does guarantee they won’t sell it. Once they realise that bitcoin is here to stay, they will relent. A decade from now, MSFT will lead the Dow’s list of dividend payers, while bitcoin will be more valuable than any company that is alive today.
Every Tuesday, I write ByteTree ATOMIC. This is Bitcoin analysis covering technicals, on-chain, macro, investment flows and a snippet about the crypto space - find out what I really think!
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