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Hedge fund shaking up Microsoft is a kinder, gentler barbarian

October 10, 2013: 1:09 PM ET

ValueAct's Jeffrey Ubben is up 20% this year, and Microsoft isn't even its biggest success.

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ValueAct's Jeffrey Ubben

FORTUNE -- Microsoft's management's biggest worry these days may not be Apple or Google, but an investor out of San Francisco.

Earlier this year, Jeffrey Ubben announced at a conference that his hedge fund ValueAct had bought $2 billion worth of Microsoft's shares. The investment might have been seen as a vote of confidence in Microsoft and its management.

But in late August, Microsoft (MSFT) said long-time CEO Steve Ballmer would be leaving in the next 12 months. Now some investors are reportedly pushing the board to oust chairman Bill Gates. Ubben and ValueAct have never publicly criticized Ballmer or Gates. But it's widely believed Ubben and his fund are behind the shakeup. Just days after Ballmer's announcement, Microsoft said it would add ValueAct partner Mason Morfit to its board, a sign that the hedge fund wants more control, and possibly a change of direction for the software giant.

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Microsoft's stock is up nearly 10% in the past six months, despite the fact that the software giant announced disappointing second-quarter results. It's a better run than Microsoft's shares have had in a while -- a sign that Ubben has been able to convince some of his peers that Microsoft is not the dead money investment many have long believed.

"I was seriously thinking of shorting Microsoft," says hedge fund manager Whitney Tilson, who also runs investment conferences at which Ubben has spoken. "But his Microsoft presentation talked me out of it. It was a very compelling contrarian take."

Microsoft is far from ValueAct's best performer this year. Shares of Bausch + Lomb owner Valeant Pharmaceuticals (VRX), which is ValueAct's third-largest position, are up nearly 80% this year. The fund also owned nearly $1.5 billion worth of Adobe Systems (ADBE) at the end of the second quarter. Shares of the software maker are up 30% this year. Its second-largest position, wireless company Motorola Solutions (MSI), is up just 7%.

In all, ValueAct's fund was up 20% through the end of September, which was about four times better than the average hedge fund did in the first nine months of the year. It helps that ValueAct is a long-only fund at a time when the market has been generally headed up. But ValueAct is also a concentrated portfolio. The fund owns just 12 stocks, which increases the risk the fund will falter. But Ubben and his partners have clearly been choosing their investments wisely.

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Ubben has done well outside of the market, too. In August, he and his wife sold their 8 bedroom, 8,500 square-foot-home in San Francisco's tony Pacific Heights neighborhood for $8.8 million. The couple bought the house in 1998 for $3.5 million. Ubben declined to comment for this article.

Ubben's success comes at a time when activist investors, the more generous term for those once called corporate raiders, in general are in vogue again. Ubben's approach though does seem more activist than raider. ValueAct does tend to take large stakes in companies and push for board seats. Unlike other activists, though, Ubben rarely releases letters denouncing the managements of companies he invests in, or makes his fights public. He has a reputation of generally being willing to work with the top management of his targets, though he has pushed executives to the exits in the past.

Ubben's investing style seems to come from his roots in private equity. Before ValueAct, he ran a private equity fund for Richard Blum, the husband of California Senator Diane Feinstein. In 2000, he founded ValueAct with Peter Kamin, who Ubben had known from his time at Fidelity. Both had been analysts for legendary stock picker Peter Lynch. Kamin left ValueAct in 2011.

Not all of his deals have worked out. In 2007, he teamed up with Silver Lake Partners to buy financial technology company Acxiom (ACXM). Before the proposed acquisition was announced, ValueAct had acquired more than 13% of the software company. Silver Lake eventually pulled out of the deal, causing Acxiom's shares to plunge 20%.

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Ubben was also the second-largest shareholder of Martha Stewart Living Omnimedia (MSO) in 2002 when the company's namesake was accused of insider trading. But in that situation he was able bail himself out. Ubben took over as chairman when Stewart was forced to temporarily resign. He promised to pay key employees their bonuses for two years, no matter how the company performed. And he recruited a new CEO. He also reportedly directly negotiated a deal with fellow hedge funder Edward Lampert, who controlled K-mart, to extend the retailer's deal with Martha Stewart until after its founder could return to the business. Three years later Ubben's investment in Martha Stewart had more than doubled in value.

"The company was in turmoil, and advertisers were fleeing. Ubben was instrumental in helping the company through its issues," says Charles Koppelman, who joined Martha Stewart's board of directors around the same time as Ubben. "He's incredibly smart and a great investor."

Many seem to be noticing. ValueAct now manages $12 billion, up from $2.5 billion at the end of 2009. Of course, that's pushed Ubben and his fund toward larger and larger prey, including Microsoft.

Ubben has said that the market is too focused on Microsoft's failures with mobile devices and software, as well as its aging operating system. He says even if you exclude the money Microsoft earns from Windows, the shares appear cheap. Microsoft's real jewel, according to Ubben, is the business software like e-mail system Outlook that companies pay annual subscriptions for. At Tilson's September investing conference, Ubben said he thought Microsoft was positioned to do better than Apple (AAPL).

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The question, of course, is whether Ubben's typical strategy will work with such a large company. ValueAct acknowledged the risk in a recent letter to shareholders. Usually the fund targets smaller companies in which it can accumulate a stake of 15% or more, giving the fund leverage to push for changes. But even at ValueAct's largest position, its more than $2 billion investment in Microsoft equals less than a 1% stake in Microsoft.

Prominent Microsoft analyst Rick Sherlund of Nomura says the only thing that will end Microsoft's long slide would be to break up the company. Sherlund and others believe Microsoft spends too much of the company's collective resources defending Windows. At 1%, Ubben is unlikely to be able to push through a breakup. Despite that, Ubben has been able to push through some changes. And the stock price jump means that other investors are interested in riding shotgun.

"Besides being smart, he's a straightforward guy with a reputation of treating people fairly," says Jerome Lande, a rival hedge fund manager at Coppersmith Capital who initially tried to block Ubben's Acxiom deal. "A lot of the success of his fund has to do with the fact that he's got a good strategy."

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About This Author
Stephen Gandel
Stephen Gandel

Stephen Gandel has covered Wall Street and investing for over 15 years. He joins Fortune from sister publication TIME, where he was a senior business writer and lead blogger for The Curious Capitalist. He has also held positions at Money and Crain's New York Business. Stephen is a four-time winner of the Henry R. Luce Award. His work has also been recognized by the National Association of Real Estate Editors, the New York State Society of CPA and the Association of Area Business Publications. He is a graduate of Washington University, and lives in Brooklyn with his wife and two children.

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