Microsoft Surface Will Destroy PC Sales

Aug.30.12 | About: Microsoft Corporation (MSFT)

On October 26, Microsoft (NASDAQ:MSFT) will release its Windows 8 software alongside its Surface tablet. This package deal highlights Microsoft's march to bridge gaps between the smartphone, tablet, and personal computer (PC) platforms. If Microsoft is successful, its deep-pocketed Silicon Valley rivals Apple (NASDAQ:AAPL) and Google (NASDAQ:GOOG) will follow suit and introduce more functionally complex tablet designs to the marketplace. At worst, the Microsoft marketing machine will confuse ordinary technology buyers and cannibalize sales within the very same traditional PC market that it dominates. PC Magazine technology writer Dan Costa is spot on when he opines that Windows 8 is a "huge gamble" for Microsoft.

Microsoft's Image

Microsoft is now cast as the underdog within the tablet market. Meanwhile, Violet Blue and ZD Net report that Apple and its "fan boys" have united to form a phalanx around market share through lawsuits and intimidation tactics against criticism. Apple's dominance of the counter-culture set emerges as direct consequence of an integrated product line that includes the iPod, iTunes, iMac, iPhone, and of course, the iPad. During third quarterly period ended June 30, Apple sold 17,042 iPads, which is a spectacular 84% increase above the year-over-year period. For Q3 2012, Apple posted $9.2 billion in iPad related revenue. Last quarter, the iPad accounted for roughly 25% of Apple's total $35 billion in sales.

Certainly, Microsoft executives would love to get a piece of this tablet action and drive bottom line growth. To do so, Microsoft must rehabilitate its image away from the out-of-touch relic that introduced Zune and Bing to the marketplace. With the Surface, it is imperative for Microsoft to offer a viable alternative to both the Apple iPad and Samsung Galaxy Tab market leaders. Writer Daniel Bailey dismisses the Samsung Galaxy Tab as a "big smartphone."

Microsoft Windows 8 and Surface Specifications

Windows 8 software will launch as a fusion of conventional smartphone, tablet, and PC interfaces. For example, laptop and desktop personal computers will offer touch screen technology, while Windows smartphones and tablets are now set to feature Office functionality. The Surface will allow for more computing firepower above the conventional tablet best used for Internet access, gaming, and taking pictures. As multiple technologies converge together, the PC market is most at risk. PC sales alongside Microsoft profit growth have remained stubbornly stagnant since late nineties Y2K hysteria.

Microsoft Surface specifications are indicative of a trend calling for tablets to ultimately replace notebook computers. The Surface tablet is notable for its sleek profile and portability. The Windows 8 Pro Surface weighs in at 903 grams and is 13.5 millimeters thick. The 10.6-inch screen offers high definition videos. For portability, the Surface keyboard and kickstand can be folded up to double as protective covers.

The Surface tablet can convert into two separate cameras, while also featuring speakers and microphones for video-conferencing. One attached USB port provides flexibility for printing documents and charging smartphones. Microsoft offers its Surface with 32GB, 64GB, and 128GB of memory. The Microsoft Surface is effectively a low-powered notebook computer. This machine is therefore ideal for the education market, as it allows students to read digital text, formulate calculations, and type out basic documents.

In terms of Surface pricing, Microsoft executives have remained mum up to this point. Technology writers present contradictory reports opining that the Surface will price anywhere between $199 and $1,000. According to Forbes, Microsoft is set to offer its Surface for a mere $200.

I am speculating that the rumored $200 price tag may be a suitable entry point for the low-end and Windows RT Surface at 32GB memory. Most likely, the Windows 8 Pro Surface will retail closer to $500. Microsoft, with its deep pockets, can afford to sell product at cost to steal market share. After selling Surfaces cheaply, Microsoft can lock customers into Office 365 subscriptions to generate regular cash flow.

In either scenario, the Microsoft Surface is at the forefront of a computing revolution that will inevitably make the PC go the way of the horse and buggy.

The Bottom Line

Analytical firm International Data Corporation (IDC) claims that the PC market will experience 5% year-over-year growth in 2012. For 2012, The International Data Corporation IDC estimates that 365 million PC units will be sold globally. Going forward, IDC projects approximately 530 million in PC unit sales for the year 2016. This data suggests that growth will largely come from laptop sales within emerging markets. For mature markets, such as Japan, Canada, Germany, and the United States, the IDC expects PC sales to flat line into the near future. The IDC defines PCs as desktops, notebooks, and laptops.

Meanwhile, analyst Richard Shim calculates that tablet sales will accelerate quickly and overtake the PC by 2016. Shim highlights the arms race between Microsoft, Google, and Apple as key drivers powering this trend. Microsoft's Windows 8 Pro Surface packages Intel processing power that effectively renders what Shim refers to as the "Ultraslim PC," irrelevant. A more focused look at corporate financial reports will reinforce claims that tablets are cannibalizing sales of conventional computers.

For Q3 2012, Apple reported a 13% year-over-year drop in quarterly unit sales for its Mac desktops. This drop off stands in sharp contrast to the 84% increase in iPad unit sales for the same period. At $675, Apple stock now carries a price-to-earnings ratio of sixteen. Apple shares are wildly cheap, considering the fact that this corporation has grown earnings at a 66% average annual clip over the past four years. Apple shares remain the best way to leverage the Tablet Revolution.

Up The 5 Freeway in Redmond, Microsoft's profits have stalled out near a $17 billion watermark over the past five years. Contrary to the hype, Microsoft's looming Windows 8 and Surface tablet rollout will barely move the profit needle of this $260 billion corporation. Microsoft will largely cannibalize its own sales because this corporation historically butters its bread through Windows software licensing. Microsoft fits the definition of a beta stock that merely tracks the S&P 500 Index and pays out regular dividends.

For Hewlett-Packard (NYSE:HPQ) and Dell (NASDAQ:DELL), the financials are quite bleak. The HP and Dell brands are both now synonymous with missed earnings, layoffs, and analyst downgrades. As such, Hewlett Packard and Dell shares have both lost more than 60% in value within the last five years. These story stocks of yore will trend towards zero as the break down of the PC commodity business model continues.

In the technology sector, survival of the fittest capitalism works at warp speed.

Disclosure: I am long AAPL. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.