Kill The Microsoft Surface Tablet

| About: Microsoft Corporation (MSFT)
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The Apple iPad sets the pace for the tablet market.

Releasing Office for iPad literally renders the Surface tablet obsolete.

Microsoft may unlock shareholder value after killing the Surface tablet line.

On October 26, 2012, Microsoft (NASDAQ:MSFT) launched its Windows 8 operating system, as the first major software release out of the company in four years. At that time, the Microsoft marketing apparatchik and fawning press systematically fell into lockstep formation and lauded Windows 8 as "revolutionary." The Windows 8 concept, also known as Metro, was billed as a fusion between traditional smartphone, tablet, and personal computer machines. One year later, Microsoft released its Windows 8.1 upgrade as a feigned compromise between the demands of personal computer and Metro loyalists. For the sake of article simplicity, the Windows 8 movement has branched off to include Phone, 8.1, RT, and Surface systems.

The Microsoft Surface was engineered to bridge the gap between personal computer and tablet platforms. As workstations, Microsoft Surface billfolds include fully functional keyboards, Office software, and USB ports for printing out documents. Despite these efforts, however, the technology commentariat has largely railed against Windows 8 as a "failure," "disaster," and "debacle." The March 27 launch of Office for iPad has effectively rendered Surface hardware obsolete. Going forward, Microsoft would unlock shareholder value, if it were to shut down the Surface tablet, and embrace its roots as a software company.

Apple iPad Locus of Control





Q1 2013

Q1 2014

Apple Revenue







iPad Revenue







iPad Unit Sales







iPad Revenue Per Unit Sold







iPad % of Apple Revenue







Source: Apple Earnings Releases and SEC Filings

The 2010 Apple (NASDAQ:AAPL) iPad launch revolutionized computing and the mobile ecosystem. For its 2013 fiscal year, Apple reported record sales of 71 million iPad units and $32.0 billion in operating segment revenue. The iPad generated 20% of total corporate revenue through Q1 2014, which largely coincided with last Holiday Season. Over the next year, Apple shareholders may expect the company to bank $450.00 in revenue per iPad unit sold. At this price point, the average consumer may be in the market for a 16GB Wi-Fi iPad Air, which does retail for $499.00. A recent report out of research firm IHS presented $274.00 in 16GB Wi-Fi iPad Air bill of materials and manufacturing costs. According to these estimates, Apple would take down $18 billion in gross margins, if it were to ship 80 million iPad units through 2014.

Microsoft now offers a $350.00 rebate to Apple iPad owners who exchange their used machines for a Windows phone or tablet. The exchange may serve as evidence that Microsoft has already targeted Apple as the leading competitor within the tablet space. Be advised that the latest installment of the Windows tablet branches off into the Surface 2 and Surface Pro 2. The Surface Pro 2 prices out for between $899.00 and $1,799.00. At these levels, the Surface Pro 2 competes directly against the MacBook Air and 13-inch MacBook Pro computers that also range between $999.00 and $1,799.00. Certainly, the typical consumer would consider the Apple laptops to be of far greater value than similarly priced Microsoft tablets.

The aforementioned triangulation of Apple financial data, however, would indicate that the $449.00 32GB Surface 2 tablet literally serves as a more so ideal apples-to-apples comparison to the iPad product line. The Surface 2 tablet weighs in at 1.49 pounds (676 grams), while also standing 10.81 inches tall by 6.79 inches wide. The Surface 2 tablet presents graphics at 1920 X 1080 resolution and also converts into two separate front (3.5-megapixel) and back (5.0-megapixel) cameras. For the sake of comparison, the iPad Air, which is often celebrated for its portability, weighs in at a mere one pound. Apple has already promoted the iPad's 64-bit A7 chip for its "desktop-class architecture" and "killer performance." Apparently, the A7 chip drives an iPad Air that is "twice as quick" as the previous Apple tablet edition.

Microsoft has billed the Surface tablet more so as a functional workstation, while Apple has played upon its artistic image to hawk iPads like hotcakes. Today's one-sided war is eerily similar to the 2006-2009 "Get a Mac" campaign. In these series of advertisements, a chic, yet practical Apple hipster was juxtaposed against a Microsoft corporate stiff. A recent report out of research firm IDC listed Apple as the top tablet vendor, in terms of sales, with a 33.8% Q4 2013 market share. Microsoft, despite its $330 billion in market capitalization, has failed to emerge as a top-five tablet vendor. According to IDC estimates, fifth-place Lenovo (OTCPK:LNVGY) shipped 3.4 million tablets through the 2013 Holiday quarter.

Microsoft Office for iPad

Microsoft Office for iPad is now available free of charge in three separate PowerPoint, Excel, and Word applications at the App Store. Free versions of the Office applications allow for the basic opening, viewing, copying, and sharing, and sorting of content in PowerPoint, Word, and Excel. Be advised that users must actually purchase an Office 365 subscription, in order to actually create new documents. From there, Microsoft claims that Office 365 subscriptions allow for "robust editing" and "rich formatting." Office for iPad serves as another gateway into cloud computing through OneDrive.

The Office 365 subscription suite does branch off into home and business wings. The fully loaded Office 365 Enterprise E3 package provides an unlimited user base access to Office Online and desktop versions of Word, Excel, PowerPoint, Outlook, OneNote, Access, Publisher, and Lync. Office 365 Enterprise E3 requires an annual commitment, which costs $240.00 per user, per year. Office 365 Small Business Premium is available for up to 25 users and also grants access to Office online and desktop versions of Word, Excel, PowerPoint, Outlook, OneNote, and Lync. The Office 365 Small Business Premium package is billed annually at $150.00.

Most likely, Apple iPad consumers would be in the market for home-based solutions. Office 365 Home Premium offers Office Online, in addition to 7 GB of online storage. Desktop versions of Word, Excel, PowerPoint, and Outlook are also made available. Office 365 Home Premium may extend above five separate desktop computers and five separate combinations of Windows and iPad tablets. Microsoft offers its Office 365 Home Premium service for $9.99 per month.

Microsoft will effectively pay Apple 30% commissions upon Office 365 subscriptions sold through the App Store. Again, Apple may take down a projected 80 million in iPad unit sales through 2014. At this rate, Apple and Microsoft may collect a respective $250 million and $1 billion in iPad related software application sales. On paper, these results would be a literal drop in the bucket for technology giants that combined for more than $250 billion in 2013 sales. Perhaps of even greater importance, is the idea that offering up the Office crown jewel to the Apple iPad is a concession of defeat at Redmond.

The Bottom Line

Microsoft has classified its businesses according to Devices and Consumer and Commercial operating segments. The Devices and Consumer and Commercial operating segments also include Licensing, Hardware, and Other sub-categories. Devices and Consumer Licensing is largely comprised of Windows operating system and "non-volume" consumer Office licensing sales. Devices and Consumer Hardware was set up to include Xbox and Surface revenue. Commercial Licensing, as it includes server products and enterprise sales, has emerged as Microsoft's core business unit.

Be advised that Microsoft's newer operating segment divisions make for somewhat awkward financial comparisons. Microsoft classified its businesses according to Windows, Server and Tools, Online Services, Business, and Entertainment and Devices during its fiscal 2013 ended June 30. That year, Windows Phone and Surface sales were included as part of Entertainment and Devices, while Office generated more than 90% of Business division revenue. Taken together, Windows ($19.2 billion) and Business ($24.7 billion) accounted for $43.9 billion of $77.8 billion in 2013 total revenue at Microsoft. As highly efficient businesses, Windows and Business divisions also tallied a respective $9.5 billion and $16.2 billion in operating income. Alternatively, Entertainment and Devices accounted for a mere $848 million in operating income off $10.2 billion in segment revenue. Microsoft's aggregate 2013 results did include a $900 million Surface RT inventory write-down.

Most recently, Microsoft Devices and Consumer Hardware tallied $411 million in operating income off $4.7 billion in Q2 2014 segment revenue. Still, the Surface appears to be all but a non-factor, in terms of generating real bottom line results at Microsoft. Microsoft, of course, has unwittingly hammered the final nail into the Surface coffin through its Office for iPad offerings. For now, Microsoft shares deserve a hold rating. Investors may consider buying stock, if new CEO Satya Nadella can actually come up with the gumption to reverse and trash the work of predecessor Steve Ballmer and King Maker Bill Gates.

Microsoft is a software company that must kill the Surface tablet.

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.