Bill Gates and the Story of Microsoft

Bill Gates at CNBC Town Hall Event, November 2009

In recent years, several of our investment commentaries have focused on some of the great entrepreneurs and giants of the business world over the past three or four decades. As was the case in the latter half of the 19th century, the recent past has seen a number of men build companies that harness technology in ways that have dramatically influenced our culture, our country, and indeed, the world. Like J.P. Morgan, Andrew Carnegie, J.D. Rockefeller, Thomas Edison, and Henry Ford before them between 1865 and 1900, these men are in many ways larger than life. Thus far we have written about Steve Jobs (Apple), Mark Zuckerberg (Meta Platforms, formerly Facebook), Elon Musk (Tesla among others), and most recently Jeff Bezos (Amazon). The one technology giant whom we have not written about is Bill Gates, and this commentary aims to remedy that omission. It is intended to help the reader grasp the ways in which Bill Gates and the company he cofounded, Microsoft, have changed the modern world.

William Henry Gates III was born in 1955 into a successful family. His father, William Henry Gates II, was a well-known lawyer with a successful practice in Seattle. This allowed his mother, Mary Maxwell Gates, to leave her job as a schoolteacher and focus on charitable and civic activities. Together they became the preeminent power couple in Seattle. The second of three children, Gates was nicknamed Trey to distinguish him from his father. Trey was described by his father as a nonstop reader. Perhaps one of the reasons for this was a contest that his school held every summer to see who could read the most books. From birth, Trey was extremely competitive, and he often won this contest. In his teenage years, Gates read the entire 22 volumes of the World Book Encyclopedia. And, according to his father, Gates had an exceptional memory, remembering almost everything he read. As he reached his teen years, Gates became very self-assured, even argumentative, challenging his parents frequently.

His parents enrolled Gates in the 7th grade at the Lakeside School — Seattle’s most prestigious private school. This was where he met Paul Allen, who was several years older, with whom he would later cofound Microsoft. In his memoir, Allen described Gates in his teenage years as follows: “He was really smart. He was really competitive; he wanted to show you how smart he was. And he was really, really persistent.”

When Gates was in 8th grade, Lakeside School’s Mothers Club donated the proceeds of a rummage sale, $3,000, to the school’s Computer Club. The club used the donation to access a timesharing system, using an ASR-33 Teletype terminal connected to a mainframe. Gates obsessed on software programming in his high school years, ignoring athletics and other pursuits, and spending as much as 20 hours a week on programming. Allen also spent endless hours programming software at Lakeside, becoming even more proficient than Gates in computer hardware. Later, Gates recalled that he had access to a mainframe computer, which helped both him and Allen in creating future software. During the spring of his senior year, Gates’ parents allowed him to work full-time writing code for the Bonneville Power Station in Washington state. Then in 1973, it was off to Harvard for Gates.

In 1975, shortly after Intel introduced its 8080 chip, a small firm in Albuquerque, NM, named Micro Instrumentation and Telemetry Systems (MITS) introduced a computer kit called the Altair. This machine inaugurated the personal computer age. The MITS Altair 8800 had neither a programming language nor an operating system. If one bought the Altair 8800 microcomputer then, the first step was to assemble the parts of the computer. And of course, the machine did not have a monitor, keyboard, or mouse. Writing code meant typing in either zeros or ones for the whole program. In these early days of microcomputers, the MITS Altair 8800 was sold largely to “hobbyists.” The MITS Altair 8800 was featured in Popular Electronics and aroused a lot of interest. Soon MITS was besieged by firms promising to develop BASIC programming that would work with the Altair 8800. Gates and Allen wanted the early mover advantage. They realized the importance of this moment and wanted to seize the opportunity to beat others in the race to develop Altair BASIC, which would become the programming language for the Altair 8800. These two students, one from Harvard and the other from Washington State, worked together to create programming to enable users to program the Altair in BASIC rather than by machine code. After Allen, who by then was working for Honeywell in Boston, had demonstrated that Altair BASIC worked and that a contract from MITS had been nailed down, Gates dropped out of Harvard at the age of 19. Gates’ parents were devastated that he had left Harvard, but Gates mollified them by promising to go back later to get his degree.

In 1975, Gates and Allen moved to Albuquerque and created a partnership called Micro-Soft (later renamed Microsoft) at the suggestion of Allen, as the company was working on microcomputer software instead of mainframes. Gates took a 64% ownership stake, with Allen owning 36% of the partnership. Gates was only 19 years old. In those early years, Gates was the leader, possessing great energy, a passion for work, the ability to recruit others to follow him, and a creative vision. From the onset, he was the public face of Microsoft. For the next four years, Microsoft worked closely with MITS. Gates believed that personal computers would be useless without good software. Gates and Allen created the BASIC programming language that was used by Altair 8080, and MITS also sold versions of BASIC to other minicomputer companies that wanted to use BASIC. Microsoft received a percentage of each license that was sold by MITS. In 1978, Microsoft won a major victory against MITS in an arbitration hearing, which allowed Microsoft to sell BASIC to other computer manufacturers. In 1979, Microsoft moved to Seattle.

During the summer of 1980, IBM approved a project to build and sell a personal computer. A team from IBM went to Microsoft to discuss licensing various Microsoft programming languages as well as an operating system. Gates and Allen didn’t know anything about how to build an operating system for a PC,

so Gates referred IBM to Digital Research, Inc. (DRI), a firm knowledgeable about operating systems. Gates even helped set up a meeting between IBM and Gary Kildall, the cofounder and CEO of DRI. When the IBM team went to DRI in the San Francisco area, Kildall didn’t show up for the meeting. Instead, they met with Kildall’s wife, a cofounder of DRI, who refused to sign a contract with IBM because of the stringent NDA that IBM presented her with.

IBM then turned back to Microsoft, and Paul Allen negotiated a deal with Seattle Computer Products (SCP) to create an operating system for the IBM PC. SCP called the first version of the operating system the Quick and Dirty Operating System (QDOS). Allen closed the deal with SCP and licensed QDOS for $10,000 plus royalty payments of $15,000 for any company that licensed the software. Microsoft then negotiated a deal in November 1980 with IBM, which proved to be one of the most important strategic decisions in the history of the PC and software industry. Microsoft received only $430,000 from IBM — far less than IBM had expected to pay — but Gates and Allen gained the rights to sell QDOS, now called MS-DOS, to other manufacturing companies. They had the vision to understand that if Microsoft could place their operating system with other PC manufacturers, they would dominate the software industry for decades.

The second major event that took place in 1980 was Microsoft’s recruitment of Steve Ballmer. Gates had become good friends with Ballmer at Harvard, who lived down the hall from him in Currier House. In many ways, they were total opposites. Gates by his own admission was hyper-intense in his twenties and a nerd. On the other hand, Ballmer, who scored an 800 on his math SAT, was a very sociable creature with great interpersonal skills. He was a member of the Fox Club, a social club similar to a fraternity, manager of the Harvard varsity football team, and worked on the college newspaper, The Harvard Crimson. Unlike Gates, Ballmer graduated from Harvard and was attending Stanford Business School, when Gates persuaded him to join Microsoft as the company’s business manager. Ballmer was the 30th employee at the company. Gates promised him an equity stake of 8%, which was realized only when Microsoft had its IPO. Ballmer succeeded Gates as CEO when Gates stepped down in 2000.

In 1983, Bill Gates and Steve Ballmer wrote all of the Microsoft employees “The Application Strategy Memo,” which said that henceforth, Microsoft would embrace Graphical User Interface (GUI). GUI was an invention that came out of the famed XEROX Palo Alto Research Center (PARC) in the 1970s which PARC was never able to monetize. GUI enables the user of a PC to use a mouse to point to an icon and click on it to open an application rather than instructing the PC through digital commands. Steve Jobs at Apple went all-in on GUI, which turned out to be the right decision. Gates worked closely with Jobs during this period when the Apple Lisa was created, succeeded later by the first Macintosh (Mac) in 1984. At the same time, Microsoft was working with IBM using GUI. Windows 1.0 was released with the same point-and-click features at the end of 1985. The PC that we all use was essentially invented during this two-year window.

During this same period, Microsoft’s cofounder, Paul Allen, was diagnosed with Hodgkin’s lymphoma and stepped down as a Microsoft employee. He and Gates had serious negotiations about Allen selling back his shares but could not agree upon a price. Consequently, Allen maintained his ownership in the company and remained on the Board of Microsoft until 2000. Paul Allen’s net worth was estimated at $20 billion when he died in 2018.

After 12 years as a private company, Microsoft went public in March 1986 at a price of $21 per share. At the offering, Gates owned approximately 45% of the shares of Microsoft, and his net worth was roughly $315 million. Ballmer’s 8% stake was worth around $56 million. Several years later, the company introduced Microsoft Word to the mass market with Windows 3.0. Excel had already been released several years earlier, and began to steadily take market share away from Lotus 1-2-3, which had been the industry standard in the 1980s. In an enormously successful marketing campaign, Microsoft introduced Windows 95 in 1995. In the first year after its release, 40 million copies of Windows 95 were sold. Importantly, with internet usage taking off, Microsoft’s browser Internet Explorer was bundled together with Windows 95 and later Windows 98. This was later to be a central part of the U.S. government’s suit against Microsoft for becoming a monopoly. Revenue from Microsoft’s applications was rapidly outpacing its sales from its operating systems. From June 30, 1987 through June 30, 1999, Microsoft’s revenue grew from $346 million to $19.75 billion — an astounding compound annual growth of approximately 34%. The chart below shows the price of Microsoft’s stock from its IPO (adjusted for stock splits) through the end of 1999:

During this period, the price of Microsoft’s stock appreciated roughly 600-fold. Since 1999, its stock has risen approximately seven times; thus the price of the stock has risen approximately 4,200% since its IPO.

The aggressive sales distribution stance that Microsoft took under Gates’ leadership finally resulted in unwelcome government attention during 1990, when both the U.S. Department of Justice (DOJ) and the Federal Trade Commission (FTC) initiated separate actions. By 1993, the FTC commissioners were deadlocked, and as a result their inquiry was closed down; however, the DOJ continued its antitrust investigation and ultimately forced Microsoft to sign a consent decree. At the core of these cases were sales practices that the government believed unfairly discouraged customers from trying other programs. Microsoft agreed to modify these practices and stop requiring royalties on each computer sold by a supplier of its operating system, even if the computer didn’t contain Windows.

Over the next four years, the DOJ monitored Microsoft’s sales practices and concluded that Microsoft was not abiding by the consent decree. Accordingly, in 1997, the DOJ and 20 states filed an antitrust lawsuit against Microsoft, alleging that the company was using its monopoly power to restrict competition in the browser and operating system markets. Specifically, the DOJ alleged that Microsoft was using anticompetitive practices to make it difficult for consumers to install or uninstall competing software. The lawsuit focused on whether Microsoft’s bundling of its Internet Explorer browser with its Windows operating system was legal. The government argued that this practice gave Microsoft an advantage over competing browsers, such as Netscape Navigator and Opera. The case went to trial.

In November 1999, in his finding of fact, Judge Thomas P. Jackson declared Microsoft to be a monopoly power in violation of the Sherman Antitrust Act of 1890. Many believed that Gates’ arrogant and uncooperative behavior during his 20-hour deposition led to Judge Jackson’s finding. Moreover, the government alleged that Microsoft had not abided by the 1994 consent decree by bundling Internet Explorer into Windows. As a remedy, on June 7, 2000, Judge Jackson ordered Microsoft to be split into two companies: one which would produce the Windows operating system, and the other which would produce other software components, including Internet Explorer.

Microsoft’s highly anticipated appeal of the decision was successful, and in 2001, Judge Jackson’s decision was overruled by the D.C. Circuit Court of Appeals. Microsoft ultimately settled the case with the DOJ by agreeing to make it easier for competitors to integrate their software into Windows. The DOJ monitored Microsoft’s behavior, and Microsoft was not released from the sanctions until 2011. In all, Microsoft was in the DOJ’s sights from 1994 to 2011 — 17 years.

Throughout it all, Gates defended the actions of the company, maintaining that consumers were not harmed by Microsoft and were benefiting from the products the company created. Although Microsoft ultimately preserved its form, Gates suffered both from his resentment over the government intervention, as well as the significant distraction from his visionary role at the firm. The stress of the long-running legal battles took a toll on him, and after 25 years as CEO, he stepped down in 2000, naming Steve Ballmer as his successor. He kept his position as Chairman and added the title of Chief Software Architect.

Microsoft’s stock peaked in late 1999 just before the internet bubble burst in early 2000. In late 1999, the price touched $60 a share. Earnings per share for 2000 were forecast to reach $1.70. This translates into a P/E ratio of 35 — expensive but not exorbitant — because of the strong growth outlook relative to many of the internet stocks, which often had anemic sales and were losing money. But the next 15 years saw Microsoft’s stock trade below its 1999 peak and as low as $16 a share in March 2009. This was the “lost decade” when the total return of the S&P 500 from 2000 through 2009 was down over 9%. And Microsoft’s earnings per share, which had been increasing dramatically in the 1990s, only grew from $1.70 per share in 2000 to $2.63 per share in 2014 — barely 55% in 14 years. The chart below shows the trajectory of the stock during this period:

Many investors during this period blamed Steve Ballmer, who was CEO from 2000 to 2014, for this poor performance; however, it had more to do with a consolidation period for Microsoft as well as the need for both a new culture and new products. These arrived with Ballmer’s successor, Satya Nadella, as described on the following page.

Unlike Steve Jobs and Elon Musk, Bill Gates never had a biographer like Walter Isaacson spend days and weeks at his side. Much has been written about Gates but not in the comprehensive way that Isaacson did with Jobs and Musk. So, it is more difficult to know the complete man. But, without doubt, Gates is in the same category of genius as Jobs, Musk, Zuckerberg, and Bezos. For example, there is evidence to suggest that Gates, during his high school years at Lakeside School, was considered the top math student in the state of Washington. Also, how many high school students have read all 22 volumes of the World Book Encyclopedia? Another key personality trait, commented on by friends and foes alike, is Gates’ exceptionally competitive nature. This was clearly demonstrated at Microsoft where Gates did everything possible to win — whether it was by aggressively gaining market dominance for Microsoft, increasing his ownership in the firm, or gaining more power at the firm that he cofounded. Another character trait was that Gates was an extremely demanding boss. His cofounder and great friend, Paul Allen, wrote about this in his memoir, Idea Man: A Memoir by the Cofounder of Microsoft. Gates routinely insulted his colleagues and subordinates, routinely saying things like: “That’s the stupidest f……g thing that I have ever heard.” His insulting late-night emails to subordinates became almost a badge of honor. But he also was a visionary with exceptional business acumen. He was much more adept at winning business through great negotiating skills than by inventing new products. Gates’ real genius was understanding two things early on: that personal computers would be ubiquitous, and that control of the industry was not in hardware but through controlling the operating systems and applications of the PC.

Gates understood that with great wealth comes social responsibility. To act on this, Gates and his wife, Melinda, had already established the Bill & Melinda Gates Foundation in 2000. Entire books have been written on this foundation. There is not time nor space to go into details about Gates’ philanthropy but here are three key data points. So far, his foundation has given away over $70 billion. The annual budget is currently $8 billion; 2,000 staffers work at the foundation, and its assets now stand at around $67 billion. Gates’ giving priorities have been education and health care in emerging nations. When he was 55, Gates, together with Warren Buffett, created The Giving Pledge, which committed signatories to give away at least half of their wealth before they died.

What was Gates’ family life like? In 1987, when Gates was 32 years old, he met Melinda French, who was working at Microsoft. Born and raised in Dallas, Melinda French received her undergraduate and business degrees at Duke before moving to Seattle. Seven years later, Bill and Melinda married in Hawaii at a wedding ceremony attended by luminaries such as Warren Buffett. Steve Ballmer was his best man. Over the years, Bill and Melinda had three children — two girls and a boy. Gates always projected the image of a devoted family man. Thus, it was startling to learn in 2021 that Bill and Melinda were getting a divorce. Since their separation during COVID in 2020 and subsequent divorce, details have been leaked that Gates had a wandering eye. In 2019, a Microsoft employee informed the Board about an alleged affair that she and Gates had in 2000, and following an investigation, Gates stepped down from the Board in 2020. During the Jeffrey Epstein scandals, Gates was named as one of Epstein’s acquaintances. The Gates’ divorce has, nonetheless, been described as amicable; when Melinda resigned as cochair of the Foundation to set up her own foundation, she was said to have received $12.5 billion for her charitable work.

As mentioned above, Satya Nadella succeeded Steve Ballmer as CEO in 2014. Born in India, Nadella, whose father was a Marxist civil servant and mother a Sanskrit scholar, joined Microsoft in 1992. Educated at the world-renowned Hyderabad Public School, Manipal Institute of Technology, and the University of Wisconsin, Nadella moved to Silicon Valley in 1990 to work for Sun Microsystems. Up until then, his main passion had been cricket. Recruited in 1992 to join Microsoft to work on Windows NT as a product manager, Nadella shifted his focus from cricket to software and climbed the ladder of the company. Since he became CEO in 2014, the price of stock has risen from the low $40s to $420 today. What has been Nadella’s secret of success?

In his book, Hit Refresh, published in 2017, Nadella writes that when he became CEO in 2014, he believed that his most important priority was changing Microsoft’s culture. The culture had become super competitive, with divisions and departments competing against each other, and exceedingly bureaucratic. Greatly influenced by his son’s cerebral palsy, Nadella wrote that he had learned the value of empathy and desired that empathy be at the heart of Microsoft’s culture. He wanted the leadership of the firm to help rediscover the soul of Microsoft. He wanted Microsoft’s 100,000 employees to hit refresh — to become reenergized, be renewed, and rethink their purpose. And Nadella succeeded in changing the firm’s culture.

Before becoming CEO, Nadella had been responsible first for developing Microsoft’s search product, Bing, and then its cloud product, Azure. This success is what helped Nadella land the job of CEO. Azure, together with its gaming products, LinkedIn, and Artificial Intelligence (AI), has caused Microsoft’s revenues and earnings to soar over the past decade. In Microsoft’s fiscal year ending June 20, 2015, total revenues were $93 billion, and recurring earnings per share were $2.38. In Microsoft’s 2024 fiscal year, revenues grew more than 150% to $245 billion, while earnings per share rose more than five-fold to $11.82. At its current stock price, Microsoft has the third highest market capitalization in the world, $3.1 trillion (behind only Apple and Nvidia). At the moment, Microsoft’s largest business sector is Intelligent Cloud (revenues of $88 billion), whose crown jewel, the cloud-based Azure product, grew revenue 31% last year. The Microsoft Office, LinkedIn, and Dynamics product division had sales of $69 billion, while the More Personal Computing division generated sales of $62.4 billion. Approximately 12% of revenues come from hardware products. Analysts project calendar year 2025 EPS of $14.29, which translates to a P/E of 29.4. Rich, but not unreasonable for a company that has invested over $14 billion in OpenAI and is growing earnings at 14-15%.

How can we sum up the legacy of Bill Gates? He and Paul Allen started Microsoft with the goal of helping to put a computer on every desk and in every home. It was a bold and ambitious vision, and one that was accomplished. Another way of saying this is that Microsoft democratized personal computing and made it accessible and user-friendly. The company’s innovation has significantly increased the productivity of global businesses. Their cloud and AI platform will continue to unlock human creativity and potential, and this will hopefully produce the next Bill Gates and more great companies in the years to come. And at BFS, Microsoft is one of our top holdings, in the majority of our clients’ portfolios.