Microsoft's Earnings Report And Its Future - Part 1

| About: Microsoft Corporation (MSFT)

Microsoft (NASDAQ:MSFT), in a recent press conference, released its Q3, 2013 financial results. The company's overall revenue and earnings per share grew by 8% year over year. This growth was achieved amidst falling PC demand, which is linked to the company's revenues.

Based on segmental financial data, the largest revenue growth was achieved in the Entertainment and Devices Division, primarily driven by sales of the MSFT Surface. MSFT's Business Division continues to dominate the company's overall revenues, comprising around 31% of total revenues. However, the growth has significantly slowed, affected by the decline in the PC market.

Similar to revenues, the largest growth was achieved in the Entertainment and Devices Division, moving from losses in Q3 2012 to profits in Q3 2013. The segment achieved a growth rate 52% YoY for the nine months ending in March 2013. The MSFT Business Division continues to be the most significant part of the company, although its percentage of total profit declined slightly. The online services division has continued to post losses as the market continues to be dominated by Google (NASDAQ:GOOG). However, the company losses dropped primarily due to an increase of 22% YoY in online advertising revenues.

Windows Division

The division's revenues over nine months achieved a growth of only 4% YoY as the PC market saw a decline in demand.

As the PC market declines, the only other source of revenue growth available for the division is through the smartphone and tablet market.

Thus, the current market scenario explains that the Windows OS was not a popular choice for smartphones and tablets, which resulted in stagnant growth for the division. However, the division experienced a phenomenal growth in revenues over the last quarter, primarily due the introduction of the Windows OS-based tablet, the MSFT Surface, which gained a large sales volume, close to 1 million shipments in the last quarter of 2012, according to one estimate. This large quantity of sales resulted in a 40% increase in non-OEM revenues in Q4 2012.

As the Windows tablet continues to gain momentum in the market, the revenues of the division will also improve. The new Windows Blue, which is to be released later this year, would address issues faced by users of Windows 8, and would probably enhance user experience. As the company shifts its focus away from the traditional PC market and towards the more lucrative smartphone and tablet market, its revenues are expected to achieve high growth, resulting in better earnings for the division.

Server and Tools

The segment achieved a revenue growth of 11% and a growth in profits of 17% in the most recent quarter. Revenues for System Centers grew 22% and SQL Server, a market leader according IDC 2011 estimates, achieved a revenue growth of 16%.

For the company, the largest growth opportunity would likely come from the cloud computing arena. As server shipment growth is expected to be modest and as cloud computing workloads are expected to surpass traditional ones, this market segment provides an ample opportunity for the company to achieve growth. MSFT, seeing the potential in this sector, has focused its efforts on enhancing its position in the market. As many as 75% of the developers at MSFT are working on cloud-related projects.

As is evident from the two graphs above, over the past year MSFT has gained a substantial presence in the market, surpassing GOOG to become the second-largest cloud platform. According to the survey conducted by Forrester Research in Q3 2012, Amazon (NASDAQ:AMZN) still continues to be the favorite amongst developers, but Azure has shown impressive growth, with close to one-fourth of the respondents stating that they have used Azure to deliver custom applications.

The future outlook of MSFT Azure is promising, as a large number of respondents to the question regarding the change in use hinted towards a growth in the deployment of MSFT Azure. The results of Forrester's research survey are depicted in the graph below.

Based on the positive market response and the company's increased focus towards cloud computing and virtualization, I believe the company would gain substantially from the growth potential in the market. Thus, I believe that the server and tools division would experience high growth in revenues and earnings in the future.

Online Services Division

The online services division experienced growth revenues of 18%, driven by a 22% increase in online advertisement revenues. In terms of profitability, the company experienced close to 45% lower losses, an enhanced performance due to increase in revenues and cost management.

MSFT's Bing Ads search spending increased 48% YoY as compared to 20% achieved by GOOG, due to strong impression growth on expanded keyword-to-query matching. The search engine's ad clicks also rose by 44%, while CPCs increased by 2%.

Historically, Google has dominated the global market of search engines with 86.64% of the total searches in February 2013, coming through GOOG. According to ComScore, even in the U.S. market GOOG continues to dominate, with 67% of core searches coming from the website. Microsoft sites contributed to 16.5% of the total explicit core search in the U.S.

The mobile sector, which includes both cell phones and tablets, accounted for around 25% of online searches in Q1 of 2013. In terms of mobile searches, Bing could only capture 1% of the total mobile online searches in March 2013, as compared with 94.75% and 3.45% achieved by GOOG and Yahoo (NASDAQ:YHOO). Devices highlight the benefits of default search provider agreements, as Android devices generated 6% of total GOOG clicks but just 1% of Bing clicks. Similarly on the Kindle Fire, on which Bing is the default search option, Bing generated twice the click share of GOOG. Thus, as more devices become available in the market that have Bing as the default search option, such as tablets with Windows OS, the company's click share should increase.

The company's partnerships with YHOO and Facebook (NASDAQ:FB) have helped the company in improving the division's performance. However, I would expect the division to continue to see poor performance as GOOG continues to dominate the search engine market and Android devices, on which GOOG is the default search option, are expected to dominate the tablet and cell phone market.

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.

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