Where Are The Missing PCs?

 |  About: Microsoft Corporation (MSFT)
by: Paulo Santos

On March 7 I wrote that there were signs Windows 8 wasn't selling well, and thus that Microsoft (NASDAQ:MSFT) could have trouble meeting estimates, at least in its Windows division. The article hit the spot in that earnings estimates at the time of publication were $0.77 per share, and Microsoft ended up reporting $0.72 (construed as a "beat" as estimates had been lowered all the way down to $0.68 by then).

As Microsoft reported, it also pulled somewhat of a surprise, by reporting Windows sales, which were flat year-on-year. As we will see, there's still reason to believe something quite different from that is really happening.

Missing PCs

If we go as far back as we can in IDC's Worldwide PC data, we can construct the following table (Source: IDC):

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Doing the same for Microsoft's Windows division gives us this (Source: MSFT's 10-Qs and 10-Ks):

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The two are pretty closely related, because if we divide Microsoft's Windows revenues by IDC's estimate of Worldwide PC units sold, we get this up to Q3 2013 …

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So with Microsoft's overwhelming domination of the PC market, Microsoft got a rather stable $50 per unit sold (a slight downward bias must be because of Apple's slightly increased share). Obviously the true number must have been a bit higher, accounting for the share of the PC market, which isn't Microsoft's, but what matters is that it was rather stable.

Then, come Q4 2012 and Q1 2013, something happens … Microsoft's revenue per Worldwide PC sold shoots up. This could either mean Microsoft was charging more for each PC, Microsoft had taken substantial market share (which we know is not true) or … the revenues being reported by Microsoft included a lot of licenses, which Microsoft sold into the channel, but the channel did not sell into customers. Additionally, a final hypothesis would be that tablets, unaccounted for here, made for the difference.

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How many units could Microsoft have stuffed the channel with?

If we assume Microsoft is still earning about $50 per unit sold, a stable relationship up until recently, we can compute how much Microsoft is reporting in excess revenues, and dividing that by $50, we can estimate how many units such represents.

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Now, these are pretty incredible numbers. At this point, if Microsoft is charging about the same for Windows 8, then we have reason to believe Microsoft might have sold as much as $2.19 billion in excess licenses not yet sold through the channel or sold as upgrades. This would represent 43.8 million PCs or 57.4% of the market IDC reported for Q1 2013.

Also, using the same $50 yardstick, we can compute the run-rate implied by IDC's numbers. This implies $4.5 billion for Q4 2012, and $3.8 billion for Q1 2013. The $3.8 billion is 17% below the $4.6 billion reported by Microsoft, and would be our best estimate of the present, real, Windows run rate.

Could tablets be it?

No. IDC also reported on tablet sales for Q1 2013, and put Windows 8 + RT sales at 1.8 million, so those would hardly scratch this estimate.


There continues to be a reason to believe Microsoft sold a substantial number of licenses into the market, which haven't yet flowed through the channel. Some of those will certainly be upgrades of old computers, but even then reason remains to expect a substantial slowdown in Microsoft's Windows division. Our best estimate would indicate that presently new PCs can account for a Windows division run rate of $3.8 billion per quarter, well below the $4.6 billion Microsoft reported on Q1 2013 (flat with Q1 2012).

Microsoft might have chosen to match this drop in demand to Q2 2012, because then the Windows division saw a significant slowdown in anticipation of Windows 8. But the truth is that right now the slowdown looks structural and will have to flow thorough Microsoft's accounts at some point.

This leads me to believe Microsoft will see further downward earnings revisions. The June quarter is at $0.76 per share and September is at $0.68. I believe these, along with revenue estimates now at $20.8 billion and $19.1 billion, will head lower. I cannot recommend shorting the stock given Bernanke and the overall market bullishness, but still wanted to point out the increased risk from this.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.