Just when you think you've found a fool-proof business, a better fool evolves to mess things up. I've long thought that Microsoft (Nasdaq:MSFT) shares seemed much too cheap, but held off on buying for fear that ongoing operational shortcomings would obscure that value. With a fiscal fourth quarter that was weak across almost every metric, it looks like that has come home to roost.
Although I think the base Windows, Office, and server/tools businesses are still valuable, it's increasingly difficult to trust management to adequately execute or communicate their plan. So while I still think these shares are too cheap on a cash flow basis, it's likely going to take something more dramatic than another reorganization or stabilization in the PC business to get these shares closer to fair value.

SEE: A Primer On Investing In The Tech Industry
Disappointing Results Down The Line
Microsoft accomplished something relatively rare among tech companies with multiple lines of reporting segments – the company missed everywhere. The misses weren't particularly large (at least among the revenue lines), but it's hard to come away from these earnings feeling good unless you believe it's just a transitional period for the company.
Revenue rose 6% on a GAAP basis, and the 4% miss relative to the average sell-side estimate wasn't all that bad. Windows revenue was up 7%, and about 8% shy of expectations, and was even worse on an adjusted non-GAAP basis (down 6%). Server/Tools revenue rose 8%, as did Entertainment revenue, and Online was up a similar 9%. Microsoft's Business division once again saved the day with nearly 15% growth, but this was about 3% shy of estimates.
With the company discounting Windows for tablets, seeing significant COGS pressure in devices, and aggressively building out Azure, a price had to be paid in the margins. Gross margin fell five points on a GAAP basis, missing expectations by about four and a half points. Operating income was down 5% on an adjusted GAAP basis, and the company was about seven points short on operating margin.

SEE: Analyzing Operating Margins
Will A Restructuring/Reorganization Really Solve The Problems?
Not too long before these earnings, Microsoft laid out its intentions for a reorganization of the business. The company is looking to refocus around the core concepts of Windows (OS), Apps, Cloud, and Devices.
That all sounds fine, but the reality is that reorganizations are usually the final step in tacitly acknowledging that a company's operating approach isn't working, and I'm not sure Microsoft is really aiming towards the right solutions. Although the company has a lot of ideas here and there that could work – Skype, the Windows Phone partnership with Nokia (NYSE:NOK), growing middleware offerings – I don't have a lot of confidence about the ability to execute.
As it is, Office is still a strong and lucrative business. Likewise, the company's Windows/SQL Server, Azure, and Hyper-V are likely underrated by the market – Azure, for instance, has a market share lead on Amazon's (Nasdaq:AMZN) much-discussed AWS. And though I don't think Microsoft is going to unseat IBM (NYSE:IBM) or Oracle (Nasdaq:ORCL) in middleware, they're stronger in business intelligence and analystics than Wall Street typically wants to acknowledge.
But for all of the good, there is at least one bad. Management still hasn't done much with Skype, and Google (Nasdaq:GOOG) continues to kick them around in markets ranging from online advertising/search to mobile operating systems to cloud apps. And don't forget the Surface – maybe this tablet was just a way of getting more attention for Windows on tablets, but it has hardly gone well for the company.
The Bottom Line
Even though there's ample criticism and skepticism regarding Microsoft, I'm actually surprised there hasn't been more investor activism in the pursuit of bigger changes (like a new CEO). There's value here, and I don't think the current management has done anything to deserve the benefit of the doubt regarding their ability to realize that value.
I'm still expecting Microsoft to grow its free cash flow at a 3% to 4% rate. With that, the fair value for the shares is well into the $40s. Even if the company were to generate 0% free cash flow growth, fair value would still come in around $37, and fair value net of cash and investments would come in around $28 to $29. Consequently, I think there's already a huge amount of skepticism at work in the stock, though performances like this suggest that such skepticism is coming from a pretty reasonable place.