Microsoft Surface No Match For Apple iPad, Samsung Galaxy Tab

| About: Microsoft Corporation (MSFT)

On October 31, 2012, Apple (NASDAQ:AAPL) filed its 2012 annual report with the Securities and Exchange Commission. For its 2012 fiscal year, Apple shipped 58.3 million iPad units. This performance accounted for $32.4 billion out of Apple's $156.5 billion in 2012 total net sales. In terms of units sold, the iPad platform achieved 80% growth between 2011 and 2012. This mark followed 334% growth between 2010 and 2011. Apple shipped 32.4 million and 7.5 million iPad units in fiscal 2011 and 2010, respectively. Certainly, Microsoft executives and engineers looked towards Apple's financials at the time, and shared visions of bringing their own tablet and growth engine to market.

On October 26, 2012, Microsoft (NASDAQ:MSFT) launched its Surface tablet. Prior to launch, an overzealous Dan Lyons of The Daily Beast described the Surface tablet as a "revolution." According to Lyons, the Microsoft Surface tablet "marked the end of the PC Era." Unfortunately for Microsoft, Lyons has been proven half correct. Over the past year, the personal computer market has deteriorated sharply. At the same time, however, Microsoft Surface sales have been especially weak. The entire Windows 8 movement has failed to generate bottom line growth for Microsoft shareholders. Going forward, the Surface tablet will be the effective odd man out, as it battles against the Apple iPad, Samsung Galaxy Tab, and even the Amazon (NASDAQ:AMZN) Kindle. Microsoft shareholders should consider immediately selling off this stock.

Microsoft Surface Specifications

Microsoft engineers designed the Surface to effectively close the technical gaps separating personal computers from tablet machines. To do so, the Surface tablet has been built as a portable billfold that can be opened up to convert into a kickstand, keyboard, and touch screen interface. As a workstation, the Microsoft Surface was able to run Office, which has been made complete with Word, Power Point, and Excel programs. The Surface could also be attached to a printer for creating physical documents. Upon release, however, the Surface was already playing from well behind the branding and near infinite application networks supporting the Google Android and Apple iOS ecosystems.

On July 18, 2013, Microsoft reported its fourth-quarter and full-year results for fiscal 2013 ended June 30, 2013. For the year, Microsoft posted $21.9 billion in net income off of $77.8 billion in revenue. Redmond classified its revenue figures according to Office, Windows, Servers, X-Box 360, Consulting, and Other. Between 2012 and 2013, only "Other" achieved significant growth. "Other" accounted for $7 billion in 2013 Microsoft revenue, which was up from $4.7 billion in revenue tallied the prior year. If anything, the Microsoft Surface has taken money off the table at Microsoft. Microsoft itemized one fiscal 2013 $900 million charge related to Surface RT "inventory adjustments." These results stood in sharp contrast to the performance down The 5 Freeway in Cupertino, where Apple has already generated $57 billion in revenue off the iPad through the last nine months ended June 29, 2013. Wall Street was clearly not impressed with the Windows results, because traders dumped Microsoft stock to $31.40 and a 13% loss in the immediate hours following the company's Q4 2013 earnings release.

Wayne Williams and Beta News already ripped Surface sales as "pathetic." On August 5, 2013, research firm IDC released its report estimating tablet sales for the second calendar quarter of 2013. Microsoft was not listed as a top-five tablet vendor. As operating systems, Windows and Windows RT accounted for 2 million shipments during this recent quarter, for a somewhat meager 4.5% share of this market. Broken down further, the Windows RT operating system powered only 200,000 tablet unit sales through the second quarter. Going forward, Windows 8 and Surface upgrades will do nothing to change the dynamics of this market. If anything, the Google Android - Apple iOS duopoly will expand upon its present strength. In terms of unit sales, the leading Android operating system experienced 163% year-over-year growth during calendar Q2 2013. A strong case can be made that Windows 8 was the epicenter behind this bust and rout.

The Competition

To date, Apple has best leveraged the tablet revolution to generate revenue and turn profits. On July 23, 2013, Apple issued the latest financial report for its third quarterly period for fiscal 2013. At Apple, Q3 2013 ended on June 29, 2013. During this latest quarter, the Apple iPad accounted for $6.4 billion out of the company's $35.3 billion in net sales. Technology investors, however, should recognize that iPad sales actually began to decelerate through Q3 2013. Last quarter, Apple iPad sales declined by 14% and 27%, respectively, according to unit sales and revenue. Again, this decline in sales may have largely been attributable to the aggressive growth and adoption of the Samsung Galaxy Tab. In either scenario, the Google Android - Apple iOS duopoly maintains an effective vice grip over both the tablet and smart phone markets. In order for the Surface to achieve a measure of success, it must secure a position as a viable third-wheel option alongside the entrenched Android and iOS platforms.

If anything, Amazon may prove to be Microsoft's most formidable competitor. Amazon has been consistently accused of effectively dumping product on the market at cost, in order to drive sales of high-margin content and durable goods. Amazon Kindle tablet price points have historically ranged between $69 and $400. These prices compare quite favorably to the Surface RT and Surface Pro that retail for $349 and $799, respectively. On August 6, 2013, Amazon founder Jeff Bezos announced that he was buying The Washington Post (WPO) for $250 million. Bezos' move into Old Media will enable even greater horizontal integration for the cross selling of content, goods, and services through Amazon Kindle tablets.

As a standalone device, the inevitable Microsoft Surface upgrade will not be able to compete at neither premium, nor value price points. The Microsoft Surface has also been attached to a lackluster Windows 8 operating system. In his December 9, 2012 piece for Tab Times, Dan Rowinski ridiculed Windows 8 as a "boondoggle." Rowinski went on to blast Microsoft as an "arrogant tech company that believes it should succeed just because it put a lot of work into a product and throws a lot of money behind it."

Microsoft's latest annual report did include a Windows operating system classification. The Windows operating system accounted for $17.8 billion, $17.3 billion, and $17.5 billion in revenue for the respective 2011, 2012, and 2013 fiscal years. According to research firm Net Market Share data, Windows 8 sales have significantly lagged behind the much-maligned Vista, at similar points in both product life cycles. This trend is indicative of consumers preferring to maintain old computers, instead of upgrading to Windows 8. The cold reception towards Windows 8 does not bode well for future iterations of the Surface tablet.

The Bottom Line

Microsoft is a strong sell. Microsoft and its Windows ecosystem should be priced more so as a utility, instead of trading near historical S&P 500 level valuations of 12 times trailing earnings. Value investors who prefer to leverage strong cash flow and dividend income can simply buy Altria (NYSE:MO) or Coca Cola (NYSE:KO), without taking on the risks of another disappointing product launch out of Redmond. As wings of the Microsoft ecosystem, conservative investors should also consider selling off Hewlett Packard (HWP), Dell (NASDAQ:DELL), and Nokia (NYSE:NOK). In effect, Windows was a cancer that forced original equipment markers to compete against each other on price and stymied innovation. Long-term investors should only consider returning to the Microsoft--Windows fold, after either the OEM's strike out on their own to develop software in-house, or begin to entertain offers to support Google Android.

Disclosure: I am long MO, KO. 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.

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