Microsoft Once Again Apple's Biggest Threat

Nov.25.13 | About: Microsoft Corporation (MSFT)

Microsoft (NASDAQ:MSFT) has struggled, is struggling and perhaps will continue to struggle to make headway in mobile devices. It didn't get off to a good start last year when it bungled the launch of its Surface tablets. The first mistake was offering two distinct operating systems, Windows RT and Windows 8, which only confused potential buyers. That particular decision was understandable because Intel didn't at that point have a sufficiently power sipping chip ready for Microsoft to use in its entry level Windows Surface tablet. What is less forgivable are some of the other choices Microsoft made: only having a 1366 x 768 pixel screen on the RT model, leaving out Outlook from Office as well as the high cost of both machines, $499 for the Surface RT and $899 for the Surface Pro and another $99 for the Type Cover/Touch Cover. That's twice the cost of an iPad.

It's not too surprising then that Microsoft's share of tablets didn't take off and so lackluster were sales of Windows devices that few app developers bothered to create apps for Windows. This has led to a vicious cycle of low Window device sales leading to fewer apps and then to several hardware makers - Samsung (OTC: OTC:SSNLF), HTC (OTC:OTC:OTC:HTCCY) etc. - abandoning Windows as a platform.

Android triumphant?

With Microsoft out of the picture, it seems Android/Google (NASDAQ:GOOG) is winning the ecosystem war against Apple (NASDAQ:AAPL). Gartner has Android at 82% of the smartphone market and IDC has Android at 65% of the tablet market. However, each manufacturer has its own "skin" - an additional proprietary software layering on top of stock Android, which results in all sorts of problems for Android.

First of all it can lead to laggy performance even on top range phones such as Samsung's Galaxy S4. Secondly, app developers have to support all of the different forks of Android that hardware makers have implemented, as well as several versions of Android: i.e. Android 4.0 aka Ice Cream Sandwich, Android 4.1 to 4.3 which is Jelly Bean and now Android 4.4 called Kit Kat.

The final thing to note is that both Apple and Android devices are primarily for consumption: playing games, watching movies, listening to music, reading books, as well as surfing the net and reading emails. Consequently, it matters a great deal that Apple has over 500 million credit cards on file while Google has hardly any.

What this all means is that though total app revenue sold through Google's Play store has now reached parity with iTunes, revenue per device is much lower, and Android app developers have much higher costs developing and supporting each app for Android than on Apple's ecosystem. Apple is always going to be the first choice for new apps and many app makers will continue not to bother with Android at all. Thus Apple will continue to be people's first choice for high end consumption focused devices.

What else can Google do at this point? If Google is out of moves, Apple will remain as the first choice for high end consumer devices.

Microsoft has best app selection: x86 programs, and killer app - Office.

Enter - or re-enter - Microsoft.

"First they ignore you, then they laugh at you, then they fight you, then you win" - Mahatma Gandhi.

Lots of people, especially those in technology, aren't well disposed toward Microsoft. Reviews of Microsoft's first foray into tablets were harsh. Reviews of the latest Surface tablets are much better, even though I sense they are given through gritted teeth.

Battery life on the on the original Surface Pro was only 4 hours, terribly weak for a tablet. That has now been increased to 7 hours for the Surface Pro 2. The kickstand has been modified so it can be used in two positions rather than just one. As I noted before, Outlook is now included as part of Office. Given that this is still only Microsoft's second tablet - the equivalent of Apple's iPad 2 - Microsoft is catching up pretty quickly on the hardware side.

Microsoft's strategy is to aim its machines at professionals and enterprise users who at the end of the day would like to use their laptop as a tablet for a bit of light media consumption or gaming or just surfing the net. With that in mind it's important to note that Microsoft actually has the best app selection, certainly the app selection with the greatest span. This is simply a result of it being able to use all the legacy Windows programs along with a majority of the most popular apps that are on Android or iOS. Only Windows 8 machines (running on x86) can run both Steam games and Fruit Ninja - and at the same time.

I wonder when at some point people start to talk about how Apple and Android are behind in applications? Will reviews of iPad or an Android tablet feel obliged to note that the tablet in question still doesn't have Office or provide universal printer support?

Conglomerates will always struggle in the long run

On the surface (no pun intended, Microsoft's current strategy looks quite different to the one it successfully used during the PC era. Then it licensed its OS to OEM's for them to build PCs. Now it is making its own devices. Before, all an OEM like Dell (NASDAQ:DELL) did was assemble a standard PC box as cheaply as possible, now there is a huge variety in potential form factor. Now, clearly, this change has been forced on to Microsoft because so many hardware makers have abandoned the Window's platform. However, unlike Apple, Microsoft is still willing to license its OS to anyone that wants it. And this will be important in the tablet, convertible, 2 in 1 devices, Phablets, what-have-you space where no one is certain yet just what consumers want in a device. The only way to find out is with a great deal of experimentation in form factor.

Samsung is the only company that is successfully launching products in multiple categories and that's hard to sustain, long term. Conglomerates are always vulnerable to losing focus as well as falling prey to internal turf wars and politics. Apple itself is starting to spread itself thin now with 4 iPods, 4 iPads, 4 iPhones and 5 Macs in its line-up. In the future, Apple may add additional, larger screen iPhones, TVs, and smart watches. The recent decision to price the Ipad Mini retina only $100 dollars less than the iPad Air and the iPhone 5C only $100 less than the iPhone 5S suggests that for Apple, worries about sales cannibalization are now the dominant concern rather than the success of any particular product.


Does this mean I'm bullish on Microsoft's stock? No because I believe it will be forced to reduce prices on Windows OSs and Office to compete in mobile. However Apple will do worse - it has gone all in becoming a consumer electronic device maker rather than software or services company. No such company has prospered for more than a decade - see where Sony (NYSE:SNE) is now.

I would expect Apple's profits to be less than Microsoft's in 5 years: perhaps $15 billion on $150 billion in revenue (~25% gross margins). Apple will likely sell a similar number of devices as it does now but for substantially lower prices as inevitably competition grinds down margins. In contrast I think $20 billion in profit for Microsoft is reasonable, this is similar (10% less) than now. Microsoft stock will probably tread water for another 5 years but that's better than the $120 - $180 (8 - 12 P/E ratio) I'm expecting for Apple's stock.

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.