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ValueAct's $2 billion bet on Microsoft could mean big changes in Redmond

The activist hedge fund ValueAct has bought $2 billion of Microsoft stock and sees it as potentially the "largest cloud-computing company in the world," with ValueAct's help.

Microsoft is sitting on $74.4 billion in cash and short-term investments as of March 31. It is hardly at risk of going broke. So why is an activist hedge fund taking a big stake in the company, and what could that imply for management?

No one is saying Steve Ballmer will be out of a job tomorrow as a result of ValueAct's $2 billion purchase of Microsoft stock, but it is interesting to hear ValueAct's CEO talk about why he bought such a large chunk of Microsoft in the first place.

ValueAct says its investment strategy involves targeting companies that are "fundamentally undervalued, and then working with management and the company’s board to implement strategies that generate superior returns on invested capital."

They will have their work cut out for them. Microsoft's stock has been essentially flat-lined for almost a decade, which has more than a few institutional investors grumbling. One analyst on Seeking Alpha questioned whether Microsoft stock was good for anything other than its dividend. Ouch.

Where ValueAct wants to go is interesting. Bloomberg quotes ValueAct CEO Jeffrey Ubben as saying "In three to five years, which is our time horizon, we’ll stop talking about PC cycles and instead talk about Microsoft as the largest cloud-computing company in the world."

Now compare that to Ballmer's vision of "Windows, Windows, Windows."

I've said in the past that Microsoft has better back-end prospects than endpoint/client. The Dynamics apps have been converted to on-demand, and now it looks like Office is making a smooth transition as well. I think Ubben has a more agreeable vision than Ballmer at this point.

With 60 million Microsoft shares in its possession, ValueAct doesn't exactly have a seat on the board of directors, but it is in the top 20 of Microsoft's largest shareholders. That list also includes Bill Gates, Steve Ballmer and Paul Allen, so let's not roll out the guillotine for Ballmer just yet.

"They’re value investors who don’t mind being activists," Colin Gillis, an analyst at BGC Partners, told Bloomberg. "If things aren’t working out, they would become more active."

That probably won't take long. The way I see it, Microsoft has until Windows Blue, aka Windows 8.1, to get its act together on the PC desktop. On the smartphone, it's even worse. Windows Phone 8 is a very nice OS and a great alternative to Android and iOS, but too few people are buying and you can't survive with two OEM partners (Nokia and HTC).

CNBC pundits have speculated that ValueAct would work with Ballmer and the board behind the scenes long before anything went public, which I understand. But history tends to show that investors like this do inevitably get involved. It might be a sale (not likely) or a change in executives or strategy, but eventually, major investors like ValueAct do make their presence known and felt. And no, it's not in your best interests, it's in the best interests of their investment. Just keep that in mind.

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