In a couple months, the holiday season in the western world will start. Holiday season is typically the most exciting time of the year for consumers as well as those companies that focus on consumer electronics. This is when most of the gifts are bought and most of the profits are collected. Microsoft (MSFT) has a great opportunity to become one of the star players of this holiday season with its new products and services.
First, the company will be launching the new Xbox during the holiday season. This time, the company aims at dominating the entire living-room experience rather than limiting itself to video games. It's been 8 years since the last edition of the Xbox was released and many people have been waiting patiently for years for the next Xbox. When Xbox 360 was launched during the holiday season of 2005, Microsoft sold 1.5 million copies within a couple of months. In fact, the company couldn't produce enough devices to meet the demand and there was a shortage of these devices all over the world. By 2008, the company was able to sell more than 10 million copies of its gaming console. Since its first launch, more than 76 million Xbox 360 copies were sold worldwide and Microsoft generated more than $20-25 billion in revenues from the device sales alone.
If past performance is the best predictor of the future performance, we can expect Microsoft to sell more than 2 million units of Xbox One, along with many accessories, games and related subscriptions. At the introductory price of $500 per unit, the company could generate $1 billion from device sales alone.
Apart from Xbox One, Windows Phone is gaining a lot of momentum lately. Thanks to Nokia's (NOK) great efforts in building multiple phone models at multiple price points, the Windows Phone project is back on track. In the last 3 quarters, the volume of Windows Phone devices grew by more than 300%. I'm sure that the growth of Windows Phone will not only continue but start accelerating even faster once the holiday season starts, because this is when most people change their phones. Between now and November, I expect Nokia to launch even more phone models and different pricing points and this is pretty good for Microsoft. While Microsoft pays Nokia about $250 million per quarter, Nokia pays Microsoft about $20-$30 per unit. If the number of Lumias sold passes 10 million, Nokia will start paying Microsoft more than what Microsoft pays it.
This is not all about Windows Phone either. Microsoft also collects royalty payments from almost every manufacturer of Android phones (with the exception of Google's Motorola). In the holiday season, more than 200 to 250 million Android phones will be sold, generating about $300 to $400 million for Microsoft in royalty payments. Keep in mind that royalty payments can count towards net profits since there aren't any ongoing expenses related to those payments.
On average, the analysts expect Microsoft to generate $23.02 billion in revenues and $0.78 in net profits in the fourth quarter of the year (which coincides with the holiday season). For the full year, the analysts expect the company to generate $82.17 billion in revenues and $2.77 in net earnings, up from $77.89 billion in sales and $2.59 in net earnings last year. If Windows Phone and Xbox One perform strongly in the holiday season, these estimates can move up substantially. In fact, more bullish analysts estimate Microsoft to earn $0.87 in the holiday season and $3.07 for the full year.
Microsoft currently has $76 billion in cash and short-term investments and another $11 billion in highly-liquid long-term investments. The company's total debt of $15 billion is one of the lowest in the technology industry. In the last 3 years, Microsoft generated $43.07 billion in cash, which comes down to $14.36 billion per year (after taxes and dividends). Being the cash cow it is, Microsoft's total cash and liquid investments will rise to $100 billion at the end of the year. Excluding this value, and applying this year's estimated earnings, the company will be looking at a P/E ratio of 7. Some people can say "PC is dead" all they want, but Microsoft has shown great resiliency in a weak PC market and the company continues to be a great investment.
I've held shares of Microsoft for a while and kept increasing or decreasing the number of shares in my portfolio depending on certain events. For example, I increased the number of Microsoft shares in my portfolio substantially when the share price fell to $27 in the winter. Recently, I bought some calls with a strike price of $35, expiring in January of 2015. I believe this is a great addition to my portfolio. If Microsoft's share price passes $35 during the holiday season, my call has the potential to double in price. While I can't give advice on option plays, I urge investors to research different tools they may have to see what works best for them.
Additional disclosure: I own shares of Microsoft as well as calls that are set to expire in 2015.