Office Will Need To Prop Up Microsoft's Earnings Ahead Of Windows 8

| About: Microsoft Corporation (MSFT)

Microsoft (NASDAQ:MSFT) is set to announce its Q1 FY 2013 earnings on Thursday. The company reported relatively disappointing results last quarter as it generated only $192 million in operating income on $18 billion in revenues primarily due to a $6.2 billion write-down of aQuantive.

The focus during this quarter's earnings will be the impact of the slowdown in global PC shipments (down 8.6% y-o-y) on Microsoft. While the decline may affect the company's earnings this quarter, we don't expect much of a long-term impact. In our opinion, PC sales were subdued due to deferred purchases as buyers have been waiting for the release of Windows 8, which is set to come out on October 26.

Overall, on Thursday, we will be specifically looking at Windows and Office sales, the success of the new Windows Server, and the impact of the company's new marketing campaign for Bing, dubbed "Bing It On."

Office Growth can Offset Windows Declines

During the fourth quarter of 2012, Microsoft's revenues from its Windows division decreased to $4.1 billion (including deferred revenues) relative to $4.7 billion in FY 11. We expect to see a similar decline in Windows revenues during this quarter because customers, who are aware that a new version of Windows will be released soon, may have decided to postpone their OS upgrades.

Unlike the slow growth in the Windows segment, the Office productivity suite maintained its growth during the previous quarter, posting a 7% gain in revenues year-over-year. Since the 2010 Office suite is not as close to the end of its life cycle as Windows 7, and we expect the revenues from this segment to continue to grow. Since this segment is the biggest contributor to Microsoft's value at around 35%, revenues from Office sales can help Microsoft offset the decline in Windows sales.

Windows Server Sales to Grow Server & Tools Revenues

Microsoft's Windows Server division has been one of its fastest growing divisions in the recent past. For example, revenue from Server and Tools grew 13% during the second quarter driven by an increase in multi-year licensing revenues. This division's revenues could be boosted by the release of Windows Server 2012, which has been given high marks by critics for its innovation. We will be closely watching Windows Server sales as this division also has the potential to become a large cash cow like the Office and Windows divisions.

Impact of "Bing It On" Campaign on Bing Market Share

Although Bing has been a platform which has struggled to gain traction throughout its short lifespan, recent results from Microsoft's search quality study and the resulting "Bing It On" marketing campaign could provide a boost to Bing's market share. Even though Bing doesn't contribute much to Microsoft's value at present, we think Bing's growth is key for an integrated experience on Microsoft devices. If Bing is able to gain market share from the recent momentum, it would gain a more formidable foothold in the lucrative search ads market.

We currently have a $41 price estimate for Microsoft, which is approximately 40% above the current market price.

Disclosure: No positions.

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Tagged: , Application Software, Earnings
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