Pressure Builds at Microsoft

Who would think that a company with a cash and investments war chest of $25 billion would be under threat from changing consumer consumption patterns and a sluggish economy and cannot do anything about it. Microsoft (MSFT) is facing this threat and for the first time in its 35 year history, the company is laying off employees and "attempting" to cut expenses.

There is currently a significant slowdown in desktop and laptop sales as both consumers and enterprises pull back on purchases. Chief information officers are simply recycling old computers, and given the massive layoffs at most companies, there is no need to buy new computers. This is exerting significant downward pressure on the client services and the business division, both of which depend on the sales of PCs and together represent 60% of revenues and more than 75% of operating income. Not good.

Even the upcoming Windows 7 roll-out is unlikely to spur significant upgrade sales, although reviews of the product has been extremely positive. Further, the rapidly growing netbook product is cannibalizing PC sales and contribute less revenues and profits for Microsoft given their low ASPs.

The online services business is facing the combined headwinds of a deteriorating online display advertising market and Google (GOOG) on search.

The entertainment business is growing strongly but operating margins in this business is minuscule.

And finally, the server and tools business, which has 20%+ margins is experiencing a pullback in demand, although growth in the most recent quarter was a healthy 15%. Furthermore, deferred revenues declined a few percentage points sequentially for the first time in several years.

So what is management doing given that these threats are beyond their control and if continued could spell the first secular decline in the company's history. They announced a headcount reduction but that only represented 2-3% of employees and most of it is not immediate and will occur over an 18 month period. In addition, despite the $1.5 billion in annual savings from the expense reductions, most analysts have second half FY09 operating expenses increasing close to $1 billion.

Management suspended stock repurchases possibly signaling that their shares could fall further - or they want to conserve cash for a Yahoo (YHOO) acquisition.

Microsoft is one of the greatest and most successful companies known to man, but given the current headwinds it is difficult to invest in this stock with conviction. Estimates on the Street are likely to come down as we progress throughout the quarter as business conditions deteriote more than expected. Thus, I am staying on the sidelines for now until I see a few of these pressures abate. See my prior write-up on the software stocks as a safe haven here.

Comments

[investor88:]

Pressure builds at Microsoft indeed, just look at the price chart. Why invest now in Microsoft when the outlook is so cloudy.

Jan 29 09:22 AM

[ajv2003:]

How big the Vista misstep turned out to be. Now with Windows 7 around the corner the consumer, personal/business, can't effort the hardware upgrade. Microsoft better start selling and improving windows XP again. Let's not forget the costs associated with the removal of the browser from the European OS, across the board, Servers & Work station OS's.

Microsoft has also lost credibility with it's consumer generally by for better than 2 years insisting there was nothing wrong with Vista. Disappointed a lot of us.

Jan 29 11:47 AM

[jack dee:]

MSFT is a track star running a 100M into a huge head wind, yes they are half a second off thier best times. But every single company who sells into these markets is off thier best times.

Get a grip.

Jan 29 12:17 PM

[Bozzo:]

It's funny that your previous "safe heaven" article was dated just a week ago.

Basically it doesn't matter to you which position to present as long as you get the article published.

But get this, whenever economy will be bad enough for MSFT to start "coughing" most other companies will be "in ER". And for the stock price, with P/E at 9 it doesn't have much room to fall. Heck, slash the price in half and MSFT might as well go back private :o)

Jan 29 01:27 PM

[msftxno:]

MS would be far better of cutting off some of the bleeding in its many poorly managed divisions. MS had to recognize, especially in this economy, they don't have to be in every market.

Example that come to mind are Zune (never going to break through in sales), MSN (very poorly run and bleeds money), their music store, etc etc. They have a rags den of business that are losing money.

Really, the only reliable cash cow is the Windows OS, and they make money even if they sell a piece of garbage like Vista. So they should get rid of the failing busnesses that are just distracting their focus and milk the OS business for all its worth, while they still can. The gravy train won't be there forever, and they are blowing it by being so unfocused and distracted.

Jan 29 03:36 PM

[Rokjok777:]

Look at their main competitors: IBM just crushed their numbers (yes, even in this environment); AAPL is cruising along with iPhone equal to half their business (when they weren't even in the phone business a few years ago); and GOOG is continuing to eat their lunch in search. So they're not competing well with any of these companies. Makes you wonder.
They bought back tons of shares at $32 but decided not to buy them back at $20?

Jan 29 03:36 PM

[neutrino23:]

MS is an odd company. In spite of having tons of talent, money, and name recognition they've had a very tough time breaking out of their core business. The only things that have worked for them is Office, windows and the server side of windows.

How to explain this? My take is that each company has its own personality, its own DNA. I've seen this a lot as I've visited many companies again and again on business over the years. In spite of the turnover in personnel the company doesn't seem to change.

MS somehow doesn't have it in them to innovate and grow new businesses. They don't have a strong personality to force them to pick one good idea and go with it. Instead they seem to be run by committee. Look at the parody created by Microsoft employees reworking iPod packaging as if it had been designed at Microsoft.
Kudos to them for looking inward like this.
video.google.com/video...

Look at the slide Bill Gates has behind him here.
ignorethecode.net/blog.../

Clearly MS has the money to hire a talented designer to provide Bill Gates with top notch presentations. The fact that they don't says that internally they don't see anything wrong with this kind of clutter. That is the source of their problem. They have extremely talented engineers and they work very hard, they just don't have a clear concept of the goal to work towards.

They might turn it around. However, I think they will really struggle in the next few years. People are finally embracing alternatives to MS Office. That will erode profits from that cash cow. Windows itself is facing competition from Linux and Apple.

I don't see them crashing but I do see them slowly losing ground year by year.

Jan 29 07:39 PM

[AdamC:]

Stock buyback in this environment is a waste of money because the world's economy is going down and down and more bad numbers will be coming up and with each set of bad numbers the share price will fall further.
Conserve the cash and use it to innovate and to buffer the downturn.

Jan 29 07:43 PM

[Forex:]

the software as a safe haven piece was based on the maintenance premise; MSFT only has one business, Servers &Tools, where that applies. And that's the only business that performed nicely in 4Q


On Jan 29 01:27 PM Bozzo wrote:

> It's funny that your previous "safe heaven" article was dated just
> a week ago.
>
> Basically it doesn't matter to you which position to present as long
> as you get the article published.
>
> But get this, whenever economy will be bad enough for MSFT to start
> "coughing" most other companies will be "in ER". And for the stock
> price, with P/E at 9 it doesn't have much room to fall. Heck, slash
> the price in half and MSFT might as well go back private :o)

Jan 30 11:14 AM

[Marcap:]

"How big the Vista misstep turned out to be. Now with Windows 7 around the corner the consumer, personal/business, can't effort the hardware upgrade. Microsoft better start selling and improving windows XP again."

I agree completely.

IMO, Microsoft's best move would be to completely scrap Vista, abandon its work on Windows 7, dust off XP and re-introduce it to the market with upgraded and continued support.

XP was/is an excellent operating system, and I suspect it will be the o/s of choice for many for years to come. Vista was/is a disaster, so much so that some computers with Vista pre-installed as being shipped with downgrade disks to allow users to revert back to XP if they so desire. There is nothing that anyone really needs to do that XP will not do, unless of course one listens to the hype from Microsoft. And like many users, I choose not to.

Jan 31 02:37 AM