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Microsoft, The Sleeping Giant

Posted on Wednesday, Jan 2nd 2008

In 2008, I hope Microsoft wakes up. With Google and Apple going gangbusters, Microsoft has threats coming at it from every direction.

As we discussed earlier, Microsoft earned revenues of $13.76 billion for the quarter ended September 30, 2007, a 27% increase over the same period of the prior year. Operating income, net income and diluted earnings per share for the quarter were $5.92 billion, $4.29 billion and $0.45, respectively. The Company beat the $0.39 consensus EPS of the 26 analysts covering the company.

Most of the gains were due to Vista, even though the OS seems to be a pretty shabby display of Microsoft’s inability to deliver quality products to the market. Even though the short terms gains are rolling in, with Vista, Microsoft has entered one of the most vulnerable periods in its history. Apple is looking very strong right now, and over the next 5 years, their share of the Operating Systems market is likely to balloon. At the expense of Vista.

Revenues from Microsoft’s Online Services Business (OSB), which is primarily online advertising, were $2.5 billion in FY2007, or under 5% of total revenues of $51 billion. We covered Microsoft’s MSN business in the context of Web 3.0 in detail in the Fall. While this remains a high growth market opportunity, my concern is that by focusing on Online Media and Advertising, Microsoft is overlooking its strength in business applications, and instead dabbling like a dilettante in things that they are not so savvy at. I would like to see them doing a SaaS roll-up (Conqur, Taleo, SuccessFactors, Omniture) instead as part of the OSB strategy.

The Company has been looking at acquisitions in the online advertising, social networking and online services front. Microsoft acquired aQuantive in the online advertising space, paying an outrageously large price.

Recently, the Company picked up a 1.6% stake in Facebook for $240 million. The deal also includes an ad deal that allows Microsoft to serve exclusive ads on the Facebook through 2011. Facebook has over 60 million users, which means Microsoft paid $4 per user for over 4 years. The real win of this deal, however, is in pricing Facebook out of the market for anything reasonable (e.g. acquisition by Google or Yahoo, or an IPO). The valuation has blown Zuckerberg’s ego completely out of proportion now, and marks the watershed event that we will perhaps look back upon as the beginning of the end for Facebook.

Emerging markets is a strong growth area for Microsoft. The nations that make up the G7 grew 29% for the quarter, but even better was an over 40% increase turned in by the combined group of Brazil, Russia, India, and China. The Company is rightly focusing on emerging markets, and that strategy is working.

In summary, I would like to see Microsoft wake up this year, and use its cash reserve to do the following:

* Refocus on business software, and do an Enterprise 3.0 roll-up.
* Implement a cautious and intelligent Web 3.0 strategy.
* Work like a dog to get Vista to an acceptable state before its core franchise slips away.

And for a change, I am really rooting for Microsoft.

ms chart 08

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