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When Microsoft (NASDAQ:MSFT) and its upcoming Windows 8 for computers was last discussed, shares were trading at around $27, with a P/E of 9.32. A target price of $28.88 was set at the time, providing investors a yield of 2.77%.

When Microsoft announced both a Windows 8-based tablet computer and Windows Phone ("WP8") last week, shares rallied to $31, a price 7.3% above the target. The company traded recently at $30.70, $2 above its target, due partly to the Windows Phone 8 announcement. In light of the appreciation in shares of Microsoft, It is necessary to re-evaluate the company.

Background

The rise of Google (NASDAQ:GOOG) Android and Apple's (NASDAQ:AAPL) iOS in 2007 happened partly because Microsoft had no growth strategy for mobile. Microsoft was busy in other areas, growing XBOX 360 and Vista. Microsoft released Windows Mobile 6.5, an inferior response that did not stop the drop in its market share for mobile smart phones. In 2010, Microsoft finally released Windows Phone 7 ("WP7"), but it was just a WinCE operating system with a Silverlight front-end.

WP8 is a significant release for Microsoft. It supports SMP, or Symmetric Multiprocessing, whilst WP7 does not. This means WP7 (currently Windows Phone 7.5) adaptors will not get WP8 upgrades or backwards compatibility for apps not recompiled for WP7. This is clearly bad news for Nokia (NYSE:NOK), whose shares traded at around $2.40 recently. Nokia's Lumia 900 was launched world-wide this year, and was released in the U.S. in April 2012. Analysts at Nomura Holdings are so pessimistic that they slashed sales forecasts for WP7 by 41% after WP8 was announced. Nokia is now seen to sell 34 million Lumia devices, or 6 to 7.5 billion euros in sales.

Microsoft tried to soften the damage to WP7 by announcing that it would release an update to Windows Phone 7.5 handsets. The update, dubbed "Windows Phone 7.8," will incorporate the Windows Phone 8 Start screen.

Unified Ecosystem

Investors should anticipate that Windows Phone 7 sales will be severely hurt. Investors with a short-term time horizon should expect shares to trade flat or drift lower. Longer-term, the WP8 and desktop Windows 8 transition will be good for the company and for shareholders. For the first time, Microsoft will have a unified ecosystem that stretches from entertainment (XBOX 360) to tablet (Microsoft Surface), to mobile.

Microsoft did not set a WP8 release date. WP8 is speculated to be launched as early as late-summer and as late as Christmas 2012. The launch date potentially coincides with rumors of an Apple iPhone 5 launch date in October. Research in Motion (RIMM) is also scheduled to release Blackberry 10 by late-summer.

With WP7 hardly gaining traction, Microsoft is making a move that is similar to that of RIM. RIM announced a new product line before its current product life cycle of Blackberry 7, ended. RIM's move to simultaneously promote the java-based Blackberry 7 while building developer support for Blackberry 10 is understandable. RIM is shifting its environment to an entirely new operating system based on QNX.

Why does the Windows Phone 8 announcement make sense?

On its blog, WP8 is touted as having many new consumer features. In addition to a start screen, WP8 will have 3 sizes of Live Tiles and additional themed colors. Microsoft chose to announce WP8 early to build a mobile developer community around native code support. WP8 offers developers:

  • Native code support for C and C++, making it easier to write for multiple platforms
  • In-app payment
  • VoIP app-support
  • Support for running location-based apps in the background

Recent enhancements by competitors necessitated a move by Microsoft to shift to a more robust Windows Phone 8 platform. Apple recently announced moving away from Google Maps, which means support for turn-by-turn navigation powered by TomTom. Microsoft said that WP8 will also have turn-by-turn navigation using Nokia's mapping technology.

Specifications on Android continue to be pushed further by Samsung, necessitating Microsoft to move its Windows Phones to multi-processor support with better displays. Samsung's Galaxy S III has a 1,280x720-pixel resolution and a Qualcomm (NASDAQ:QCOM) S4 dual-core processor. Qualcomm confirmed in a note to anandtech.com that WP8 will be powered by a MSM8960 chip, which is an S4 'Plus' Soc (System on a Chip).

Besides multi-core processor support, WP8 will support two new screen resolutions-1280x768 and 1280x720. It will also support removable MicroSD cards, NFC wireless sharing, Internet Explorer 10, and digital Wallet.

Conclusion:

Investors rewarded Microsoft shares for its progress in bringing Windows 8 across numerous platforms last week, but they should be cautious. Microsoft should still be seen as a company playing catch-up to competitors. For example, data availability on the cloud is nothing new: Apple already offers iCloud. Still, storing data on the cloud to have it accessible on XBOX, Surface, and Phone will be appealing for consumers. Microsoft's current challenge is to execute a well thought-out marketing strategy for Windows Phones. It must convince consumers to choose the future Windows 8 platform while awkwardly promoting WP7.x.

Source: How Windows 8 Will Move Microsoft Shares