Microsoft in Danger if Office Margins Fall to Google App Levels

 |  Includes: GOOG, MSFT
by: Trefis

Microsoft’s (NASDAQ:MSFT) Office Suite is a group of desktop applications used primarily for word processing (Word), spreadsheet preparation (Excel), presentations (PowerPoint), and email (Outlook).

Microsoft is releasing the full version of the new Office 2010 to businesses starting in May 2010. The May release will include a web-based version of Office for the first time. This is response to Google’s (NASDAQ:GOOG) cloud-based Google Apps productivity software which has been available online since 2007 and is increasingly gaining traction amongst both consumers and businesses.

We believe that the shift to more cloud-based software is likely to continue and result in a decrease in Microsoft’s Office software margins. Microsoft will incur higher costs as a result of delivering a cloud-based version of Microsoft Office and this can have an impact on the Microsoft’s stock.

We estimate that the Microsoft Office business (including Microsoft Dynamics) makes up 30% of the $32 Trefis price estimate for Microsoft’s stock. In comparison, we estimate that Google Apps constitutes 3% of the $703 Trefis price estimate for Google’s stock.

Cloud Based Software a Lower Margin Business

Under the cloud computing model, Microsoft would store Office programs on its own servers and deliver them to customers online. Although cost effective for its customers, cloud-based Office software will cost Microsoft more when compared to supplying software that is installed on the computers and servers of customers. Microsoft’s additional costs come from networking and computing equipment as well as additional IT and customer support staff.

What if Microsoft Office Margins Decline to Google Apps Levels?

We expect Microsoft Office Operating Margin to decline from 65% in 2009 to 62% by the end of Trefis forecast period and Google Apps’ Operating Margin to remain stable at around 50%.

However, if Microsoft were to experience a large shift in mix from packaged Office software to cloud-based Office software, its margins could decline further than we foreacast and reach the 50% margin level of Google Apps.

By decreasing the forecast for Microsoft Office Operating margin above to 50% by the end of Trefis forecast period, you can see how the Trefis price estimate for Microsoft’s stock would decrease by about $2.

For additional analysis and forecasts, here is our complete model for Microsoft’s stock.