Things Are Looking Good For Microsoft

Jul.23.12 | About: Microsoft Corporation (MSFT)

As Microsoft Corporation (NASDAQ:MSFT) announced its quarterly earnings last week, there were a lot of good news and bad news for the company's investors. Most of the negative developments were already anticipated, such as the company's huge write-off for its acquisition AQuantive. Overall, I was happy with Microsoft's results; however, the company now needs to work harder than ever to make sure the strong results continue in the future. Because the future of computing rests beyond PCs, the company needs to work very hard to make sure that it has a lot of presence in markets other than the PC market, such as the smartphone and tablet markets.

It looks like many businesses were busy with updating their Microsoft software in the last quarter. The long-term contracts for the software generated revenue of $20.1 billion for Microsoft, a higher figure than the $19.4 billion analysts expected on average. This type of revenue is considered "unearned revenue" as payments are made over a long period of time, usually spanning a few years. This metric is also helpful for future planning as it indicates how much volume the company can expect in the next couple of years.

While Microsoft keeps losing market share on the consumer side, it continues to keep its large market share in the business side. The fact that the company posted revenue increase in its business software at a time when businesses are cutting costs all over the place must be pretty positive for Microsoft. On the consumer side, many were either picking competitors' software or holding off until Windows 8 is launched.

Many people think that PCs will become obsolete once smartphones and tablets are adopted more widely. I definitely do not agree with that, particularly in the business world. On the consumer side, the tablets and the smart phones may replace the PCs, but on the business side, the PCs will continue to be dominant. The enterprises will continue to be Microsoft's cash cows for the foreseeable future. Tablets and smartphones are simply not good enough to run many of the operations needed by businesses.

Ironically, if tablets become as good as PCs in running business-related software, they would just become another form of PC. For the consumer side, Microsoft will have to wait and see how well the consumers receive the computers, tablets and phones running on Windows 8. This is where Microsoft's partnership with Nokia Corporation (NYSE:NOK) will play a huge role.

Microsoft earned 67 cents per share in the last quarter, beating the average estimate of 62 cents per share. This figure excludes the company's write-off regarding its purchase of AQuantive. After including the write-off, the company ended the quarter in a loss, and this is the first quarter that ever ended in a loss for Microsoft since it became a public company.

Currently, less than 4% of Microsoft's revenues come from its advertisement business, and many people speculate that Microsoft will get rid of this business as it turned out to be not as profitable as the company once hoped it would be. More specifically, there wasn't much harmony between Microsoft's existing systems and AQuantive products to turn the project profitable for Microsoft. The company's stockholders didn't react negatively to its huge write-off as they are still very confident about the company's future prospects.

Apart from the enterprises, one of the strongest growth drivers of the company was its Entertainment and Devices division, which posted a revenue growth of 20% from the same quarter a year ago. This division of Microsoft includes products such as Xbox and Skype. Microsoft will continue to see growth in this division. This is one of those few areas where Microsoft keeps gaining market share in a consumer driven market. I am sure Microsoft has learned many lessons from this business unit about what consumers want and what they value, and these lessons will be put to a good use when the company's next line of consumer-oriented products hit the market.

While Microsoft's enterprise presence is very strong, the company will want to gain market share in the consumer market by gaining a strong presence in entertainment and devices. The company's market share in smartphones and tablets is still minimal and it needs to increase significantly in order to make up for the drops in consumer oriented PC revenues. The smartphone and tablet market is growing so fast that it would be a shame for Microsoft not to get a piece of the rapidly growing pie.

On another positive note, the company's ever-growing cash reserves reached $72.81 billion, up from $63.64 a year ago. Of this sum, $56 billion represents the company's short-term investments and another $9 billion represents the company's long-term investments. With this much money, Microsoft could do a variety of things, including acquiring companies (e.g., Nokia), buying back shares, increasing its dividend rates or developing new products and/or services. I am sure the company will use some of its cash reserves in its self declared "war" on Apple Inc. (NASDAQ:AAPL). On a side note, the company's recent write-down will not change its cash holdings, as it was already paid for years ago.

In conclusion, positives outweigh negatives by a large margin in Microsoft's latest earnings announcement. The company continues to dominate the business world and it will have to work harder to have a significant impact on the consumer world. Microsoft's future looks bright; however, there is still a lot of work to do. Luckily, the company has every resource (e.g., cash, talent, products, services, brand name) to fight the battles in front of it.

Disclosure: I am long MSFT, NOK, AAPL.