Microsoft To Stay Strong, Despite Setback

| About: Microsoft Corporation (MSFT)

Microsoft (NASDAQ:MSFT) recently announced a $6.2 billion accounting goodwill impairment charge, primarily related to the acquisition of an online advertising agency, aQuantitative. Microsoft expects sluggish growth in the Online Services Business Division in the coming years. The charge is expected to completely wipe off Microsoft's estimated earnings of $5 billion for the next quarter.

Microsoft's Online Services Business has continuously posted losses in the past three years, owing to challenges associated with deteriorating advertising monetization, escalating online traffic acquisition costs, and falling revenue per clicks. The company's inability to generate sufficient revenues to cover operating expenses has resulted in losses for the Online Services Division.

Microsoft acquired aQuantitative, Inc. in 2007 for $6.3 billion (83% premium), by citing that the acquisition would help the company in strengthening relationships with advertisers, agencies and publishers. In addition, it would also enhance the capabilities of the MSN Network, and would support Microsoft in building effective advertising and media solutions. But the move proved to be a costly one, as Microsoft was unable to effectively monetize the synergies and added capabilities of aQuantitative in its ecosystem.

The move did not seem to be the right one for the company, which does not have any real previous experience with advertising revenue generation. The motivation behind the acquisition might be traced to the 2007 acquisition spree, in which rational advertising companies were looking to acquire firms specializing in internet advertising to tap the rapid growth in online advertising. Google's (NASDAQ:GOOG) acquisition of Double Click, WPP Group (NYSE:WPP) s acquisition of Real Media, and Yahoo (NASDAQ:YHOO)'s acquisition of Right Media are some of the notable acquisitions during that time. But Microsoft, unlike Google, was unable to capitalize on the growth of internet advertising. Now, the Redmond based company is experiencing declining revenues from advertiser and publisher tools, which are directly linked to aQuantitative, Inc.

The Online Services Division accounts for less than 5% of Microsoft's revenue mix. The revenues of the Online Services Division posted a 6% YOY growth in the previous quarter. In our recent investment thesis on Microsoft's jump in tablet computing, and on the introduction of the Windows Phone 8, we discussed a positive outlook for the company owing to strong expected growth from tablet computing and the windows phone ecosystems. Furthermore, Microsoft's Bing search engine has been gradually capturing the market share over the years, and overtook Yahoo last year to capture the second position on the leaderboard.

We believe that the recent accounting charge will affect the company's earnings in the short term, but the effect will be mitigated in the long term owing to strong expected growth from the windows phone and tablet ecosystems. Also, the Online Services Division has a minuscule share in the company's revenues.

Microsoft's shares are trading at $30.76 and have risen nearly 15% since the start of the year. The stock is currently trading at 9.7x times forward earnings. We are expecting a further upward bounce in the multiples, in the range of 12x-15x, in accordance with the historical multiples range. Therefore, we recommend buying Microsoft to take advantage of a strong expected demand of the Microsoft Surface (Tablet) and Windows Phone 8 (Mobile) in the near term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.