Microsoft (MSFT) has been criticized for its search engine Bing for a long time. Many people argued that it was a waste of money and Bing was unlikely to gain any meaningful market share in a market dominated by Google (GOOG) and Yahoo (YHOO). After all, Bing's quality of searches was not anywhere near that of its rivals. In the last couple years, things have been changing dramatically.
While Google still dominates market share in search engines, Bing has been gaining market share. According to comScore, the three major search engines that have been losing market share were Yahoo, Ask Network and AOL which means Google and Bing's recent market gains came from market losses of these search engines. Last year, Bing improved its search engine and issued a challenge where users would search the same keywords in Google and Bing simultaneously and compare the quality of the two search results side by side. It turns out that, the quality of searches conducted by Bing were nearly as good as Google in most cases. The Bing Challenge can still be taken on Bing It On website. Once entering the website, you'll be able to enter a query to make a search. The page will be split in two parts and there will be two screens with search results. While you will not be told which side of the screen belongs to Bing and which one belongs to Google, you will be asked to vote on which you think to be a superior search outcome. Microsoft claims that when people are not told which search belongs to which search engine, people's likelihood of picking Bing was higher than their likelihood of picking Google.
This reminds me of the Pepsi Challenge that was conducted decades ago where people were given unlabeled cups full of Pepsi and Coke and asked to pick which one tasted better. The results were interesting because roughly half of the people favored Pepsi over Coke even though an initial survey given to the same people showed that a great majority preferred Coke over Pepsi if they knew what they were getting.
Last week comScore announced market share of each search engine for last month. Google dominated the list with 67.0%, which was slightly up from 66.8% last year. Microsoft's Bing scored the highest gain as its market share jumped from 15.7% to 17.9%. This growth came at the expense of Yahoo, Ask Network and AOL. Yahoo's market share shrank from 13.0% to 11.3% during the same period, while Ask Network's market share slid from 3.1% to 2.7% and AOL's market share fell from 1.5% to 1.2%. If this trend continues, Google will have a market share of 70% followed by Bing's 20% by 2015.
Microsoft's "Online Services Division" posted revenues of $2.6 billion, $2.8 billion and $3.2 billion in the last 3 fiscal years. While the division hasn't been profitable in a while, much of the loss was attributable to items like goodwill impairment. In the last year, Microsoft was able to decrease its cost of revenue by 12%, while shrinking sales and marketing expenses by 15% and increasing research and development costs by 7%. Moving forward, Bing's search revenue is expected to grow in double digits while its display revenue is expected to fall in single digits, which would cause the overall revenues to increase by a single digit percentage.
As Bing establishes itself as the second search engine, it will become one of the major revenue and income generators for Microsoft. It may take a few more years before Bing reaches its full potential, but this is not all that bad. After all, as recently as last year, there were many skeptics who said that Microsoft should have written Bing off as a total failure and moved on from it. The company held onto the project and it's been doing fine after several quality improvements.
As people replace their laptops with tablets, Bing might have some trouble with growing at a rapid rate. On the other hand, as more people buy laptops and PCs that come with Windows 8, more people will be exposed to Bing. Furthermore, the increased adoption of Windows Phone will also increase the market share of Bing. It will take a while to see solid results but Microsoft might be up to something with Bing.
I'm long Microsoft despite the recent sell-off in the company's shares. In fact, I took advantage of the recent sell-off by adding more shares and some calls ($35 strike price expiring in January 2015) in my portfolio. Microsoft is still a solid company with strong earnings and solid margins (74% gross profit margin and 34% operating margin in the last fiscal year) that would make most companies pretty jealous. Excluding Microsoft's cash, the company trades for about 7 times its future earnings and the company pays a healthy dividend rate (with a healthy payout rate, which indicates that the dividend rate is safe) in order to reward the patient investors. In a market full of overpriced companies (thanks to the ongoing QE), Microsoft seems like a rare opportunity.