Microsoft’s View Of Recession

The IT giant Microsoft (MSFT) isn’t safe from the damage caused by worsening economic conditions, as was evident from their Q1 results last week. Revenue for the quarter stood at $15.1 billion, growing 9% over the year and exceeding the market’s expectations of $14.8 billion. Sequentially, however, the revenues dropped 5%. EPS grew to $0.48, beating the Street’s expectations by a cent and recording a jump of 7% over the year and 4% over the quarter.

By segment, the Clients division grew 2% over the year to $4.2 billion, while Server and Tools grew 17% over the year to $3.4 billion. The Microsoft Business Division (MBD) contributed $4.9 billion and grew 20% over the year. Entertainment and Devices contributed $1.8 billion, recording a drop of 6% over the year. The Online Services Business grew 15% over the year and contributed $0.8 billion to the quarter’s revenue.

During the quarter, Microsoft released SQL Server 2008 and Microsoft Hyper-V Server 2008 as part of their commitment towards cost-effective flexible data centers.

For the second quarter, they are expecting revenues of $17.3-$17.8 billion and revised down their annual outlook to $64.9-$66.4 billion, for growth of 7%-10% over the year. They expect EPS of $0.51-$0.53 for the second quarter and $2.00-$2.10 for the year.

Microsoft tried to mend their online business by partnering with NBC for the 2008 Beijing Olympics to make the Games the largest ever media event on the web. Through this partnership they showcased Silverlight, their tool to deliver high-quality, interactive video across the web and mobile devices. During the Games, Microsoft served 70 million video streams and 600 million minutes of video content through Silverlight.

The company is wary of the current economic conditions; according to Microsoft, “Our approach will be to tailor our business to whatever the economy brings, focusing on outperforming our competitors and in doing so, to outgrow the overall IT market. We will be agile, not only to customer demands in the changing environment but also to our own patterns of spending.”

They plan to follow a three-point strategy to soften the impact of the credit restrictions faced by their partners and customers.

First, they are focusing on providing high value products at low ownership costs. They expect their low-cost, standardized platforms and solutions to be leaders in scenarios of IT budget cuts. Their recently launched virtualization software, Windows Server Hyper-V and System Center Management Tools, is one such product that will allow customers to reduce hardware costs, increase server utilization rates, and simplify system maintenance while lowering power and facility costs.

According to a recent IDC report, Microsoft’s share of the X86 server virtualization market climbed to nearly 25%, which the company attributes to the fact that their product is “about one-third the cost of our largest competitor.”

Their second focus area is improving internal efficiency and expense management. They are targeting cost savings of $400-$500 million in the year through review of hiring, marketing, and capital budgets.

Finally, they believe the turmoil will be short-term in nature, and they will continue to focus on their long-term plans of development of IT infrastructure and growing IT penetration in emerging markets such as China.

They are still looking at acquisitions for growth. During the quarter, they announced the acquisition of DATAllegro Inc, a provider of data warehouse appliances, and Greenfield Online Inc, Europe’s leading price comparison, shopping, and consumer reviews sites.

With DATAllegro, Microsoft expects to be able to help customers keep up with the “current data explosion and allow them to benefit from the next generation of data-driven applications.” The Greenfield acquisition at $486 million will help them get a stronger foothold in the European market by helping both consumers and merchants improve commercial search capabilities, and drive greater online sales. Their technology platform and community and merchant relationships will be integrated within the Live Search platform to improve user experience. Since Microsoft is still on the lookout, I am hoping they will pay attention to the shopping list of acquisitions I identified earlier.

The stock recovered to end the day at $22.32, but has slipped since and is trading at $21.96. This is higher than the five-year low of $20.65 it reached earlier this month.

The note of optimism in Microsoft’s earnings call is the statement that they think the recession will be short-term, while a large portion of the market believes that the recession will be deep, far reaching and long term. My feeling is that it will take at least 2-3 years for the global economy to recover from this mess.