Microsoft Proved 'Less Bad' Is Good Enough

| About: Microsoft Corporation (MSFT)
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It's hard to imagine that at one point in time Microsoft (NASDAQ:MSFT) was perceived "the bully" of the stock market. Today the tables have turned and the company has become more of a punch line. But given that Microsoft still has a dominant enterprise footprint, the company is far from a pushover. This is even though it's no longer in the position to demand anyone's lunch money. But how long will investors tolerate that "Mr. Softly" has actually gotten soft?

What did Q3 prove?

As is often the case, there were several moving parts in Microsoft's performance, which included a 19% increase in earnings, which beat Street expectations by a decent margin. While bears may continue to argue the company's direction, a profit of $6.06 billion is nothing to shake a stick at, especially given that revenue surged 18% to $20.49 billion.

However, after adjusting for upgrade offers and pre-sales for Windows and Office, the numbers were not as breathtaking. Revenue was actually a bit less, arriving at $18.8 billion. Also, while the Windows business delivered revenue of $5.7 billion, which was up 23% year-over-year, it actually arrived flat when counting the promotional effort of the upgrade offer.

The Business division posted an 8% revenue increase to $6.32 billion. On an adjusted basis, it was actually 3% less. Server and Tools rose 11% to $5.04 billion. Management said that it saw a better-than-expected demand in the company's SQL Server and System Center products. That's all well and good. But it also represented a 3% sequential decline.

Similarly, while the Online Services division reported revenue of $832 million, which looked solid at 18% year-over-year growth, that segment actually shed more than 4% sequentially. If there was actually an undisputed great number, it was in online advertising, which grew 22% year over year, which posted growth that accelerated 7% from the second quarter.

Unfortunately, the online advertising business, which is included in the Online Services division, only accounts for 4% of Microsoft's overall business. This means that any incremental improvement would impact the bottom line only marginally.

Besides, Microsoft still has a long way to go to approach the advertising juggernaut that Google (NASDAQ:GOOG) has created. Meanwhile, Entertainment and Devices, although revenue arrived significantly higher at 56% year over year to $2.5 billion, it is down sequentially from $3.7 billion.

Moving forward with the competition

Microsoft's numbers will not excite the sell-side analysts. But taking everything into consideration, these results were (on balance) pretty decent. Did they prove that Microsoft is improving? I don't believe for a second they did. Although CEO Steve Ballmer lauded the company's "bold bets" on cloud services like Office 365, Xbox Live and Skype, there was no evidence to suggest that Microsoft is stealing market share in the areas that matter the most.

While I'm willing to applaud the company for its efforts with Office 365, Microsoft has not advanced its cloud services at a pace to make investors feel better about the company's declining enterprise leverage. Although the bulls may disagree about this statement, the sequential declines in Servers and Tools speak for themselves. While the numbers weren't terrible, Oracle (NYSE:ORCL) and IBM (NYSE:IBM) still remain better positioned to win market share.

Granted, Oracle didn't have an exceptionally strong quarter, either. But investors also have to be excited about Oracle's prospects for the next quarter, especially since corporate enterprises will have more clarity about government spending. Oracle is also beginning to show that it is serious about entering the telecom space after having just announced plans to buy Tekelec from private equity owners.

In other words, unlike Microsoft, Oracle is actually taking growth risks. With a company still so heavily dependent on PC sales, Microsoft's best performer was online advertising, a segment that competes directly with Google and Facebook (NASDAQ:FB). Should investors begin to apply Google's performance standards to Microsoft? The results would not look as appealing.

Here's making sense

Today, I don't see any compelling reason to hold these shares as long as Microsoft remains dependent on PC sales. I recently suggested that it was time for Microsoft and CEO Steve Ballmer to part ways. Many readers disagreed and suggested that the stock was doing well. But the company clearly isn't performing all that well. In fact, a case can be made that Microsoft has actually gotten worse since the second quarter.

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