Windows 8.1 Fail: Now, What?

| About: Microsoft Corporation (MSFT)

The Microsoft (NASDAQ:MSFT) Windows operating system is the primary engine driving the personal computer market. On October 26, 2012, Microsoft released its Windows 8 operating system, as the first major software update since the 2009 release of Windows 7. As such, the Microsoft marketing apparatchik fully mobilized prior to this launch event, and defined Windows 8 in revolutionary terms. Microsoft engineers designed Windows 8 as a work that integrated traditional smart phone, tablet, and personal computer interfaces together beneath one operating system umbrella. PC, Surface tablet, and Windows phone sales results, however, have proven that the Windows 8 launch may be described as uneventful, at best. By definition, Windows 8 has been a failure, when juxtaposed against the initial marketing hype calling for a transformative experience.

Enter Windows 8.1. On October 18, 2013, Windows 8.1 will be available for retail sale, nearly one year after the initial Windows 8 launch. At that time, Windows 8 users will be able to upgrade to the new Windows 8.1 operating system for free. The Windows 8.1 event does highlight a changing of the guard at Microsoft. Change, however, is not always a good thing. Microsoft is now attempting to be all things to all people, at the expense of alienating its staunch loyalists. At best, Microsoft stock will do nothing, but return larger portions of capital back to investors, in the form of share buybacks and dividend payments.

I am a PC.

Rival Apple's (NASDAQ:AAPL) devastating 2006-2009 "Get a Mac" advertising campaign captured the essence of the technology market. Apple then personified itself as a chic, yet eager to please hipster. Alternatively, Microsoft was a dowdy company man wearing a sack suit, who demanded help simply to stay out of his own way. The message confirmed the idea that Apple appealed to consumers, while Microsoft lorded over the staid enterprise arena. Over the past decade, Apple has brought the revolutionary iPod, iPhone, and iPad products to market. The smart phone and the tablet platforms are what ultimately emerged to drive growth at Apple. The iPhone ($80.5 billion) and iPad ($32.4 billion) generated $112.9 billion out of the $156.5 billion in 2012 total net sales at Apple.

Today, Microsoft is a fast follower behind the Apple Way. Microsoft now wants to be hip, or build upon what Wall Street analysts would refer to as goodwill. Windows 8 has been described as a modern interface, due to the presence of tile prompt commands more so similar to smart phone and tablet navigation. As such, the Windows 8 operating system was infamous for the absence of the traditional PC Start Menu. Instead of developing unique software for each platform, Microsoft has jammed a plethora of contrary functions and looks into one operating system. Staid professionals and giggling teenage girls alike have rejected the awkward Windows 8 program.

Last June 2013, Tim Anderson and The Guardian debated whether Windows 8.1 would be a "fresh start." Again, the Start feature is the focal point of comparisons between multiple versions of Windows software. Windows 8.1 has been pitched as a platform that is more so accommodative of traditional desktop users. The new Windows 8.1 Start button does open up to a menu that includes the shut down option. Anderson, however, has gone on to dismiss the Windows 8.1 Start button as "cosmetic," because it still opens up into a modern interface, instead of the traditional desktop look. Beyond Start, computer geeks will discover that Windows 8.1 does allow for a boot-to-desktop workaround, while also offering updated Bing Search and Internet Explorer 11 packages. Windows 8 and 8.1 has been compared to Vista, which underwent several adjustments before gaining traction as a somewhat acceptable operating system.

PC Market in Secular Decline

The secular decline of the personal computer may serve as evidence that Microsoft was in dire need of a grand slam homerun out of Windows 8 and 8.1, instead of a series of base hits out of annual software updates. Windows 8 has actually underperformed the much-maligned Vista, throughout similar points within both product life cycles. Reports out of Net Market Share confirmed that Windows 8 (7.4%) has only recently surpassed Vista (4.1%), in terms of market share percentages. As of August 2013, Windows 7 was still the leading desktop operating system, in terms of unit sales, with 45.6% of the market. In all, Windows systems operated more than 90% of the August 2013 desktop market. From this small sample size of data, we may infer that consumers have preferred to maintain older Windows machines, instead of shelling out cash to upgrade to Windows 8. Going forward, this trend is likely to continue, because Windows 8.1 is far from revolutionary.

Taken further, information out of research firm Gartner paints a darker picture of Windows 8 and its place within the personal computer market. Between July 2013 and August 2013, Gartner released two separate reports that summarized shipment results within the global and Western European markets through the second calendar quarter of 2013. In terms of unit shipments, Gartner reported a 10.9% decline of the year-over-year worldwide PC market between Q2 2012 and Q2 2013. Meanwhile, the consumer PC market in Western Europe actually collapsed by 25.8% during the same year-over-year time frame. Meike Escherich, Gartner principal research analyst, has already claimed that the looming releases of Windows 8.1 and Intel (NASDAQ:INTC) "will not fully compensate for the ongoing PC decline."

Bears, of course, are free to highlight that the consumer electronics market is undergoing a secular shift towards mobile that has left Microsoft on the outside looking in. Apple also reported a 14% decline in year-over-year unit sales for Mac computers, during its latest Q3 2013 ended June 29, 2013. Meanwhile, recent reports out of both comScore and IDC have highlighted expanding tablet and smart phone sales for the Apple iOS and Google (NASDAQ:GOOG) Android duopoly in the aggregate. Windows 8.1 will not alter a mobile landscape that has buried the Microsoft brand as a distant third option to both iOS and Android operating systems, and Apple and Samsung hardware, in the hearts of consumers.

The Bottom Line

On November 12, 2012, Windows President Steven Sinofsky abruptly turned in his resignation, after serving at Microsoft for twenty-three years. On August 23, 2013, CEO Steve Ballmer announced that he would retire within the next twelve months. Shortly thereafter, Microsoft issued a statement that it had agreed to purchase Nokia (NYSE:NOK) device and service businesses for $7.2 billion, while continuing to license patent and mapping technologies. These actions telegraph the idea that Microsoft itself has lost confidence in regards to the ongoing financial performance of Windows and the personal computer. Over the past five years, Microsoft has generated $26 billion in average annual cash flow from operations.

Microsoft has typically classified its businesses according to Windows, Business, Server and Tools, Entertainment and Devices, and Online Services operating segments. The Business label is somewhat misleading, as Office software actually accounts for 90% of sales for this operating segment. As such, Windows and Business share a symbiotic relationship with personal computer market performance. Be advised that Microsoft has also folded its mobile unit into the Entertainment and Devices division, which does include the popular Xbox gaming console. Taken together, Windows and Business operating segments accounted for $44 billion out of the $77.8 billion in total net sales for fiscal 2013 year ended June 30, 2013. The Entertainment and Devices operating segment posted a mere $848 million in operating income, upon $10.2 billion in revenue. In total, Microsoft collected $21.9 billion in net income, after taking one $900 million Surface charge for "inventory adjustments."

Microsoft is a strong sell. Going forward, shareholder returns will be compromised due to both Moore's Law and the Law of Large Numbers. The stock market is a pricing mechanism that discounts future growth, while offering nothing for business stagnation. Microsoft shares may therefore remain stalled near $30, while simply harvesting cash flow to pay out dividends and buy back outstanding stock. Microsoft's 3% current dividend yield does not adequately compensate owners for holding an effective utility masquerading as a technology stock. For the sake of comparison, Altria (NYSE:MO) now offers a 5.5% dividend yield, and is well known for returning large amounts of capital back to investors. Over the past five years, Altria shares have appreciated from $15 to $35, while Microsoft shareholders have received less than nothing, or negative real returns, upon their investments.

Disclosure: I am long MO. 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.