Three Acquisition Targets For Microsoft

The recession took its toll on Microsoft this quarter. For the first time in the software giant’s 23-year history as a public company, revenues declined year on year.

Q3 revenues of $13.6 billion fell 6% over the year and 22% sequentially and missed analysts’ expectations of $14.1 billion. EPS of $0.39 was in line with the Street’s expectations but fell 17% over the year and over the quarter. Microsoft managed to meet EPS expectations through stringent cost-cutting measures implemented earlier. The company had announced its biggest layoff ever last quarter.

Microsoft blamed the dismal performance on the recession’s impact on PC sales. With budget cuts all around, neither individuals nor businesses seem to be purchasing new computers. However, there was some growth in the smaller netbooks section which helped the Notebooks segment maintain flat revenues over the year. 

By segment, Clients division revenues of $3.4 billion fell 16% over the year with OEM revenues down 19% over the year. The Server and Tools division earned revenues of $3.5 billion and grew 7% over the year. Revenue growth in the segment was driven by double-digit growth in the enterprise annuity business from sales of premium editions of Windows Server 2008, SQL Server 2008 and the System Center Management suite.

As budget cuts impacted display advertising, Microsoft’s Online Services business revenues fell 14% to $0.12 billion. Online Advertising revenues were down 16% over the year. The Microsoft Business division earned revenues of $4.5 billion, whose 5% fall was led by a decline in non-annuity licensing. The Entertainment Devices division’s revenue fell 2% to $1.6 billion despite a 30% growth in the Xbox 360 business, which sold over 1.7 million consoles.

Microsoft did not issue earnings guidance for the coming quarters, but the company did say that it was not hopeful of a quick recovery. To help grow sales in the coming year, it is looking at launching major releases of some form in most divisions. These include the launch of Windows 7 and newer versions of Office and Exchange. Microsoft is also developing a new search product. I am not sure how the new releases will help drive sales, though.

Microsoft needs to focus on attacking Google where they are weak: Vertical Search. With the prevailing low valuations, they should be hunting for deals. There are three to choose from: Kayak in travel, SimplyHired in Jobs, Trulia in Real Estate. Yahoo! doesn’t seem to be going after that strategy, but Microsoft can. As I said earlier, Acc. to the IAB’s 2008 report, newspapers still constitute $34.4 billion of the total advertising budget, with Internet advertising at $23.4 billion. The most likely budget shift in 2009 will be from Newspapers to Internet Search Marketing. Microsoft, by acquiring into vertical search can contend against vertical classifieds, one of the mainstays of newspaper advertising and draw budget away in a big way.

The stock rose 14 cents to close at $18.92, taking its market capitalization to $168.5 billion.