Bull Vs. Bear - Microsoft Stinks

By Aaron Levitt | November 15, 2012 AAA

Question: Will Microsoft catch up to Apple and Google?

Bear's Response
Success in the technology sector can be summed up in one word - innovation. Some firms such as Apple (Nasdaq:AAPL) or SalesForce.com (NYSE:CRM) seem to ooze it, constantly changing with the times and adapting to new consumer or business tastes. Then there's former champion and operating system pioneer Microsoft (Nasdaq:MSFT). Forever tied to desktop computing systems due to its dominant OS position, the company has been working to reinvent itself in an age of mobility and cloud-based services. The question for investors is whether or not the tech dinosaur has what it takes to innovate. Based on its previous non-Windows attempts, the outlook may not be so good.

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A Big Bet with Windows 8
As the death of the PC is nigh and the age of mobility and tablets begins, aging Microsoft is attempting to reinvent itself as the premier cloud and smart-device leader. The company's new Windows 8 is a bold step in that direction. The radical redesign has completely replaced the familiar desktop user interface with a mosaic of brightly-colored tiles for software programs and icons. Aside from the appearance issues, the key feature of the software is that it is designed to unify Windows across PCs and mobile devices. Windows 8 will be optimized for touchscreen devices, such as media PCs and smartphones. That's a big bet that personal and key corporate users will want the PC experience, similar to what they have on their phones.

As for those devices, Microsoft has chosen to partner with Nokia (NYSE:NOK) to kick off Windows 8 for smartphones. At the same time, Microsoft has chosen to launch its own tablet computer - the Surface. The device comes with a preview of Microsoft's dominant Office productivity software suite. Currently, the popular programs - such as Excel, Word and PowerPoint - aren't available on any other tablet PC.

Microsoft has also unveiled some key upgrades and product launches in the cloud. This includes its free cloud-based storage system called SkyDrive, as well as an update to its popular Hotmail email service. Additionally, Microsoft updated its back-end software suites such as with SQL Server, Azure and Windows Server.

A Big Set of Problems Too
While the new launches could reinvigorate Microsoft, the key for investors is just how well it will execute on the challenge. So far, results have been mixed. According to CEO Steve Ballmer in a recent interview, sales of Microsoft Surface are going slowly and have been "modest." Upgrades to Windows 8 have also been modest. Analysts have pegged upgrades by consumers and enterprise users as "mixed" and a recent survey by accounting firm MYOB shows that just 12% of small business owners are planning to upgrade within the next six months. Roughly 43% weren't sure when or if they would upgrade at all. The "awkwardness" of Windows 8 may have trickled down to Nokia as well, with Lumia 920 and 820 sales estimated to remain weak.

The precedent for failure is certainly there. Microsoft's Xbox entertainment system was a loss leader for many years after its launch and its search engine - Bing - has done little to topple Google (Nasdaq:GOOG) as king of the hill. By the time it was two years old, Bing was losing $1 billion a quarter. The same can be said for its huge purchase of VoIP provider Skype, as well as its recent $1.4 billion purchase of Yammer. Cloud-based Yammer barely has any revenue. All in all, Microsoft's endeavors outside of the OS and productivity space have generally been piecemealed together. While diversification is generally a good thing, messing with the successful Windows formula may not be good for long-term success.

The Bottom Line
For investors, the steps Microsoft is taking are necessary. The preliminary results, however, haven't alleviated the pressure of rivals Apple or Google's dominant product lines eroding Microsoft's market share. The company also needs to consider future pressures, such as Research In Motion's (Nasdaq:RIMM) Blackberry 10 launch.

Those pressures may have finally gotten to Microsoft. During the company's latest earnings announcement, Microsoft saw its gross margins drop by 2.98% for the quarter and 4.3% year over year. More importantly, its Windows division quarterly revenue fell 21.7% and sank 33.4% year over year. Given how "poorly" Windows 8 and its products are doing doesn't bode well for the future.

The bottom line could be to find other tech hunting grounds elsewhere and leave the dinosaur alone.

Don't forget to read the Bull Side of this debate and weigh in with your opinion below.

At the time of writing, Aaron Levitt did not own any shares in any company mentioned in this article.

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