By Nick Blair
Expanding your portfolio with Microsoft (MSFT) will be profitable over the long run for two basic reasons. The first being Microsoft's newest operating system, Windows 8, is set to bring a touch-screen intuitiveness that has not been present in any PC operating system before. Judging by the world's infatuation with touch-screen based tablets and phones, this newest operating system is set to be a big hit prompting investors to bid the company up 20% year to date. The second reason that Microsoft is poised for big gains over the coming years is that Verizon Wireless has recently announced that they will focus heavily on making the Windows Phone OS a success. While no numerical estimates have been released on how this could affect Windows Phone OS market share directly, keep in mind that the same assistance from Verizon is what allowed Android to start off brand new against the iPhone, and end up with a current 48% market share.
These two moves are already boosting confidence in the company following the release of its lackluster quarterly earnings report. The report shows total revenue increase of 6% from the prior year (but an EPS of $0.60, down $0.01 from last year). These results may not seem very impressive but they were above analysts' expectations and the market rewarded Microsoft with a 4.6% return. Corporate demand for Windows computers was strong during the quarter and things will probably get better after the release of Windows 8. Revenue in Microsoft's business division, mostly Office products, also increased more than 9%.
Billionaire hedge fund manager David Einhorn is bullish about Microsoft as well. Here is what he said about Microsoft at the Ira Sohn Conference:
"Microsoft's business has been much stronger than the average company in the S&P over the last 5 years. Revenues have grown nearly 4 times faster at Microsoft, EPS has more than doubled, while S&P's have grown only a few percent. Microsoft has also almost doubled its dividends. While I thought Microsoft was a bargain at a small discount to the S&P, it now trades at a remarkable discount. Even as the business is out performing average S&P 500 companies by a wide margin, the advancement has been barely above average. While the S&P multiple has gone from 16 to 15, Microsoft's multiple, net of cash, has contracted from 16 to 7. The question at hand is why. Certainly Microsoft isn't getting credit for some of its achievements and prospects."
One competitor to Microsoft, Apple (AAPL), has seen some amazing gains since the beginning of the year, and at this point, the company is poised to go even higher. Apple has seen the extreme rises for a number of reasons, most notably, its unwavering fan base. The company's most recent launch, the iPad 3, sold three million units in its first weekend alone, quite interesting for a device that has faced lukewarm reviews for a lack of innovation. Of course, Apple is easily one of Microsoft's biggest competitors, and this fact has been exemplified in recent years with the release of Apple products that take a considerable amount of market share away from Microsoft with many of its devices. In fact, Mac computers gained 1.6% market share between the 4th quarter of 2010 and the 4th quarter of 2011. While this may seem like a small gain, when combined with the 54.7% tablet market share of the iPad (in Q4 of 2011), Apple is no company to scoff at. This number is even more effective when compared to PC sells. In 2010, PCs outsold tablets 20:1. In 2011, this figure dropped significantly to PC sells beating tablets only 6:1. We are actually bullish about both stocks and think that the recent 10% decline in Apple's stock price offers an opportunity to get into the company at reasonable multiples.
Google (GOOG), another competitor to Microsoft, is demolishing one of Microsoft's most recent products. Of course, Bing is the investment that Google is not allowing to gain a foothold. In fact, Google owns 66% of the search engine market whereas Bing has only a 15% market share. Both search engines are seeing small increases in market share as Yahoo continues to falter, but Bing is being operated at a loss whereas Google is making money off of its search engine.
Although Google basically owns the search engine market, it is simply not capitalizing on its mobile OS, Android, as well as it could be. The company makes money from the popular OS based only on pay per click ads, which have seen a 12% decrease in cost to advertisers from last year, a big number considering the enormity of Android. Of course, Android is in no way losing the company money. With the last number released by Google being 700,000 activations a day, analysts have been able to, based on $20 per year per customer in ad revenue, estimate that Android makes $4.68 billion in revenue. So, how does Android equate to Windows Phone OS? Well, as of right now, Windows Phone has nothing on the Android OS. The most recent number available for Windows Phone was the Q3 numbers for Windows Phone 7 and Windows Mobile, which made a dismal $613 million. While this number has seen assistance from Verizon (as mentioned earlier) and a partnership from Nokia, Windows Mobile just does not compare to Android, for now. So, based on these two competing factors, Google obviously wins out.
As far as where Google stands in comparison to Microsoft right now, it is a safer bet. Google will not be ousted for months or years to come as far as its search engine and mobile OS, but Microsoft may be taking some market share away with its new partnership from Verizon to make Windows Mobile a success.
Overall, the market's expectations about Microsoft are quite low. It doesn't have to beat Google or Apple to meet expectations. David Einhorn is right. Microsoft isn't getting credit for some of its achievements and prospects. We think the company is attractively priced with a PE ratio of 12. There is a decent chance that it will gain significant market share in tablets and phones with its new operating system. Buyers of Microsoft today are getting this potential for free.
Disclosure: I am long MSFT.