Microsoft (MSFT) has a fairly diversified business model, especially when compared to other major tech companies, so why does the stock trade like a dying tech company? Unlike some of the other tech companies, such as Apple (AAPL), Google (GOOG) and Adobe Systems (ADBE) Microsoft has a more diverse revenue stream on the surface. Adobe derives over 70% from a digital media segment, Google gets 60% from search and Apple 70% of revenue from its iPhone and iPad products, where Microsoft's largest segment generates only 33% of revenues.
Microsoft remains one of the largest software companies in the world, with recent endeavors into the hardware industry. The real question is; does its "diverse" revenue stream really make the company any more diverse? I don't think so, as the majority of Microsoft's segments are still inherently tied to the PC industry.
Microsoft's top segment includes its business division accounting for 33% of revenues. Over 90% of this segment is made up of Office solutions. However, the company is not just an Excel or Word based company; 25% of revenues are derived from Windows and Windows Live, which includes Windows operating systems for PCs.
Another 25% of revenues come from the server and tools segment, which includes server software licenses for Windows Server. 13% of revenues are from the entertainment and devices division, which includes the Xbox 360, and 4% of revenues is from the online services division and is made up of the key products Bing search and Windows Live.
Although the diversity sounds great, especially in comparison to some of the other major tech companies' revenue stream, it appears to be doing little to help the company. Microsoft has either been outpaced or fell in line with other major techs with respect to revenue growth over the past few years:
The real takeaway is that although on the surface Microsoft appears to be diversified across various segments, its business model is still heavily tied to PCs. This includes its top business division (33% of revenues), which is primarily its PC-based Office solutions, while its next segment, Windows and Windows Live (25%), is PC-based operating systems.
Meanwhile, its server segment (25%) is inherently tied to PC usage. Even though its only 4% of revenues, its Bing search engine and Windows Live products are primarily used via desktop-based Internet and applications.
What about the fundamental issues of other tech giants?
Google gets some 60% of revenues from search, and it appears that mobile search will be cannibalistic to its PC-based search. This is much the same issue that Apple is seeing with its iPad, which is eating into its Mac sales. Personal searches are increasingly getting transferred to the mobile platform, but mobile search remains fundamentally different from PC-based search, thus, costs should be driven up over the interim as the search company looks to develop its platform. However, multi-billion dollar Clough Capital has Google as its number two owned stock (see all five).
International Business Machines Corp. (IBM) has been seeing pressure across all of its markets, from the likes of Dell (DELL), Oracle and HP in its hardware server business. IBM is also trying its hand in the networking business, but is facing a lot of pressure from industry leader Cisco. As well, IBM previously enjoyed high-margins in its IT services business, but even this segment is attracting new competitors. Most notably, HP (HPQ) is making a big push to IT services in an effort to hedge its declining PC and printer (50% of revenues combined) segments.
Oracle Corporation (ORCL) is also seeing massive competitive pressures. This includes competitive pressures in its database segment from the likes of SAP (SAP), IBM and Microsoft. Oracle also faces pressures related to lengthy sales cycles in its infrastructure business. The company continues to struggle to get a foothold in the hardware market, where it is facing stiff competition from IBM and Hewlett-Packard. The storage industry is being overrun by the likes of EMC and IBM and other tech companies looking to capitalize on the high-margin high-growth cloud market (read more about Oracle).
Adobe Systems recently lowered its fiscal 2013 guidance from $4.4 billion to $4.1 billion. Adobe gets around 70% of revenues from digital media, which has a lot of exposure to small businesses looking to deliver content across various platforms (i.e. tablet, smartphones, PCs). I'm not a big fan of this niche market, as it also relies heavily on content creators, such as application developers and media professionals. This is unlike the wide consumer base that Microsoft has the capability of tapping into.
The variant view
As tablets, namely the iPad, has continued eating into the consumer PC demand market, Microsoft has been looking to diversify beyond the PC business. This includes its mobile operating system and Surface tablet. Microsoft is also one of the three largest providers of gaming hardware with its Xbox console, but that segment remains a small part of revenues, around 13%.
Meanwhile, Microsoft's Bing search engine continues to take market share from Yahoo! and is gaining on Google, but it is unclear exactly how mobile search will be utilized and received. Nevertheless, Google owns the market, with impressive lead in market share, owning over 65% of the U.S. desktop based search market, compared to Microsoft's 16.5%. What's more is that Google has 95% of the global mobile based search market share.
So where do we see potential growth? It's tablet, mobile OS and cloud businesses. However, there are various reports that Microsoft's Surface tablet has not been well received. Thus, it is up to mobile and cloud, with mobile being a potential bright spot.
Microsoft's Windows 8 mobile operating system has a solid hardware partner in Nokia. IDC expects the Windows Phone OS to be the second largest OS with a 19% global share of the smartphone market in 2016, following Android and preceding iOS and Blackberry, according to the IDC Worldwide Smartphone 2012 to 2016 Forecast and Analysis.
The only hesitation I have with Microsoft and mobile is how in fact that the market shift can happen quickly, as has been the case with BlackBerry (BBRY) over the past few years. BlackBerry went from owning over 40% of the U.S. OS smartphone market in 2009 to less than 6% today.
Microsoft's little talked about initiatives includes Microsoft server, which is looking to lead the push to cloud computing. This segment has managed to post double digit revenue growth from 2010 to 2012. Its server business currently only makes up about 25% of revenues. This is likely Microsoft's best option for growing revenues over the interim although it is not quite as "sexy" as tablets and mobile. Even still, the competition will be fierce, which I think will help push down margins in the sector over the long term.
Microsoft has introduced a number of new products across various product lines, including its Windows 8 mobile operating system and its Surface tablet, but its current business model is heavily tied to the PC industry. PC sales are expected to remain pressured going forward, namely due to cannibalization impacts from tablets.
Microsoft has a dominant position in the PC market, with its operating systems dominating competition. Again, a statement that most companies would love to be able to say, but in reality, this can be a big negative for a company when the PC market appears to be in steady contraction.
IDC expects global PC unit shipments to fall another 3% to 5% in 2013, after a 3% fall in 2012 and 2% decline in 2011. I remain cautiously optimistic that Microsoft can diversify away from the PC industry. Although it has made recent strides to do so, only time will tell if these become a meaningful part of revenues.
For investors willing to ride it out the company does pay a 3.3% dividend yield (there are a number of forgotten tech dividends).