Microsoft: No Longer A 'Boring' Investment

May.11.12 | About: Microsoft Corporation (MSFT)

Microsoft's (NASDAQ:MSFT) multi-market penetration business strategy has given it a place in my equity portfolio and the portfolios I manage. Microsoft has been a leading provider to the business markets, where it accumulated much of its vast wealth, but it has recently taken very strong and aggressive steps to penetrating the consumer markets.

Microsoft is no longer only the company that creates Microsoft Office and our operating systems; it has become much more than that. They've realized there's an enormous consumer market, relatively untouched by them, which can vastly accelerate future growth. In response to this, we've seen a shift in Microsoft's products and services; moving away from being created solely for functionality to being created for usability.

They've realized the absolutely enormous mobile, tablet, and e-book markets which they have begun aggressively penetrating. The new Windows 8 platform will be Microsoft's key in performing a successful multi-market penetration which will give Microsoft lasting market share against competitive geniuses like Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG). Why is Windows 8 so key to Microsoft's success? Its paramount importance lies in its ability to create an ecosystem for Microsoft's products and services, which will promote additional sales and customer loyalty.

Windows 8 has been widely labeled as a "game changer" because of the new functionality it brings to the mobile, tablet, and PC products. Its proprietary advantage is that it can link your phone, tablet, computer, and any other device running on Windows 8, together. It utilizes cloud technology which streamlines the seamless integration of all your products into one. Instead of your phone just being a phone, your tablet just being a tablet, and your computer just being a computer, they become extensions of each other, giving you access wherever, whenever, and however you want.

The importance in this is far-reaching and, by all means, game changing. Recent developments have come up which are positioning Microsoft for strong market success with its Windows 8 launch this coming Fall. Mobile carriers, like Verizon (NYSE:VZ), have begun pushing strongly to sell Microsoft's products to avoid paying the very large subsidies for the iPhone. Tablet and PC manufacturers, like HP and Dell, have shown very strong demand for Windows 8 and will be using it as the platform for their future tablet releases. Also, probably most well known, Microsoft has recently gained a very strong edge into the e-reader marketplace with its large investment in Barnes and Nobles (NYSE:BKS). They invested $300 million into this partnership with the crumbling retail bookstore to spit out a new company, Newco, which focuses directly on selling e-books, competing directly with Amazon (NASDAQ:AMZN). This is a market long wanted by Microsoft, especially because of its very large profitability. By providing a Nook App on all Windows 8 platforms, Microsoft dramatically increases the exposure, usage, and integration of the e-book business into its current diverse portfolio of investments.

Just some food for thought: In my opinion, Microsoft, Apple, Google, and Amazon will soon start replacing the current positions of book publishing companies. The internet has made physical book publishing a ridiculous investment in comparison to the profitability of e-books. Rather than paying the very steep costs of paper, printing, binding, and shipping, authors can just market directly to e-readers, allowing them to avoid the steep and unnecessary costs of current publications. Some may argue that publishers will find a way to control the e-book markets, but I suspect those publishers will be phased out with the current tech giants. This phase further increases the future profitability of e-books not only to Microsoft, but to all players in the e-book market.

The success of Windows 8 will layout the future of many corporations. If Microsoft is successful, which I believe it will be, it can simultaneously penetrate every market it has been struggling over: mobile, tablets, and e-readers. If, however, Microsoft's Windows 8 release doesn't succeed, then we'll likely witness the fall of Barnes and Noble, Nokia (NYSE:NOK), and the strengthening of Apple, Amazon, and Google's current market shares.

RISKS

Patent Pissing Match

Motorola, with the backing of Google, has attacked Microsoft in a legal battle over royalties for using patent standards. Motorola claims that Microsoft is infringing on its streaming and Wi-Fi technologies on the Xbox, pushing for royalty payments summing to $4 billion/year, contends Microsoft. From a general consensus, it's agreed that the 2.25% royalty fee is too severe to mandate on Microsoft, and will likely be less; however, this still poses an issue for Microsoft's bottom line profitability.

All eggs in one basket

Microsoft is currently facing a very large risk with its Windows 8 release. Prior to this, Microsoft has only slightly dabbled in these markets, not investing too much and mitigating its risk, but an analysis of Microsoft's most recent statement of cash flows shows a painstakingly huge increase in investment activity: a 63.5% increase in investments for the 9 months preceding March 31, 2012; much attributable to the future release of Microsoft's Windows 8 platform and other future releases.

If all pans out well, then Microsoft and its partners will reap the benefits of successful market penetration; however, if the release fails, then Microsoft will face very large losses from its investments. I believe that Microsoft will succeed with their Windows 8 release because of several factors ranging from strong support by mobile carriers and hardware manufacturers. Note, though, that there's strong supplier-sided support, which is a great first step in maximizing exposure; however, there must be equally strong consumer demand to meet the supply; if not, all the exposure in the world won't help Microsoft. This poses a marketing strategy nightmare for Microsoft. In the next few months, we'll begin witnessing either the genius or failure of Microsoft's upcoming marketing attempts.

Open sourcing

Microsoft's most profitable product is also in greatest position for extinction: Microsoft Office. Open sourcing, especially from Google, has led to fierce competition to Microsoft's Office software. Since Microsoft is primarily a software development company, the risk of open sourcing poses an extremely dangerous risk for Microsoft's profitability. So far, though, it has competed against Google ingeniously, by providing a functionally limited Open Office, allowing it to retain its market share, while promoting the upgrade to Microsoft Office.

Outsourcing products

Microsoft doesn't create all of its own products, but rather, it outsources to experts. Even their extremely popular Xbox was outsourced to Flextronics. The unique risk posed by outsourcing is that the success of its Windows 8 release is limited to the functionality of the hardware it runs on. Running Windows 8 on unsuitable or mismatched hardware paints a negative picture of the platform, rather than the hardware it's running on. When consumers experience issues, they usually don't blame what they're holding (the hardware), but what they're visually seeing (the software). Thus, if Microsoft wants to have a well executed rollout of its Windows 8 enabled devices, it needs to micromanage all of its suppliers using their platform.

Consensus

Though Microsoft's true competitive edge comes in software development, it has taken strides in creating a highly diversified portfolio of investments, especially in entertainment, mobile, tablet, and e-reader markets. It realizes the vast investment potential in these consumer markets which can create strong shareholder value and growth. Admittedly, they've had trouble tapping into these markets, but Microsoft's release of the Window 8 platform will become a game changer for them and the entire industry. Microsoft has their fair share of market risks, but I still believe that the upcoming Windows 8 release, combined with the very strong support from mobile and tablet suppliers, will help in attaining long lasting market share in these lucrative markets. From a risk-averse perspective though, I will wait and see how the litigation issues with Motorola start siding before investing more heavily into Microsoft.

Disclosure: I am long MSFT.