Microsoft Strengthens Its Hardware Vertical With Surface 3 Launch

| About: Microsoft Corporation (MSFT)

Microsoft (NASDAQ:MSFT) unveiled its latest tablet, the Surface Pro 3 on May 20th. The latest offering from Microsoft has a much bigger screen size at 12 inches, and has more processing power with Intel's (NASDAQ:INTC) multi-core processors. This launch augments Microsoft's ambition to emerge as a leader in the hardware space. In this article, we will analyze the trends in tablet industry and how Microsoft's tablet offering can boost its revenues.

Trends In Tablet Space

Smart connected devices, which include tablets and smart phones, are growing at a fast pace. According to Gartner, worldwide shipments of smart connected devices market grew by almost 6.7% in 2013, primarily driven by the growing tablet sales, which saw over 50% year-over-year growth. However, IDC predicts that Tablet shipment is expected to grow at a slower rate to 260 million in 2014. Additionally, Gartner predicts that tablet shipments will outpace the entire PC market by 2015.

Apple (NASDAQ:AAPL), with a market share of almost 32.5%, continues to lead the tablet industry in the first quarter while Android still continues to dominate the tablet operating system market. While Apple and Samsung (OTC:SSNGY) devices are very popular among users, lagging companies are facing difficulty in selling their tablets. As a result, several companies are trying to differentiate their products with different form factors (sizes) and at lower price points to compete with the market leaders. This has led to a more fragmented tablet industry that has different sizes and prices, ranging from $100 for a 7 inch device to over $800 for the 12 inch device. IDC estimated that downward trend in prices continued in 2013 as average selling price (ASP) for tablet will decline by 15% from $461 in 2012 to $393 in 2013. Its expects this trend to continue in 2014 and ASP to decline by 3.6%. We also anticipate that tablets will become more commoditized and that companies selling tablets will be plagued with lower margins going ahead.

Factors Fueling Tablet Growth

While rising Internet penetration globally is one of the main reasons for the high adoption of tablets, some of the other reasons that will fuel increase in tablet shipments are:

  • Evolving technology favors tablets: Smart Connected Devices (SMDs) are expected to drive 60% of total IT growth in 2014. Companies are focusing on building their cloud software and platforms as devices of the future that will run web-based cloud apps instead of native apps. Therefore, we expect more users to likely adopt tablets that require minimal storage and processing power. This change in technology is one of the biggest contributors to the growth in tablet sales.
  • Demand from emerging markets: Internet penetration is increasing in emerging markets and first time users in these countries are logging onto the Internet using smart connected devices. Additionally, buyers in these countries are much more price sensitive. We expect that demand of tablets from emerging markets will drive global tablet sales as the ASP of a PC is expected to be $600 in 2014, nearly two times costlier than ASP of a tablet.

Tablet Sales Is Central To Microsoft's Hardware Revenue Growth

With the global PC shipments still reeling from decline in demand, Microsoft is increasingly pursuing its devices and services strategy, to reduce its reliance on PCs and expand its footprint into the hardware domain. Furthermore, the company is increasingly targeting enterprise customers to reignite sales of Windows as corporations around the world continue to prefer Windows as their favored Operating System.

With Surface 3, Microsoft is targeting business/enterprise clients who have higher spending power and want the convenience of a powerful PC and tablet. According to IDC, sale of tablets to commercial will be central to tablet growth in the coming years, and it expects Windows-based devices to capture more than a quarter of the market due to the existing installed base of Windows. Since, Microsoft priced this product at a premium of $800 for the lowest model, it can lift company's revenues if the sales gains traction. If Microsoft can capture even 1% of the expected 260 million shipments, its revenues can increase by over $2 billion in 2014 at the lowest price point of Surface 3.

At present, we have $41 price estimate for Microsoft, which is approximately 3.2% above the current market price.

Disclosure: No positions