Microsoft Grows, But Future Looks Foggy

According to IDC’s recently released report, the global PC market grew 22.4% over the year to 81.5 million units. However, PC sales in the United States failed to meet the researchers’ target of 18% and grew just 12.6% over the year. PC sales in EMEA “met expectations” and Japan too saw double-digit PC shipment growth. Shipments in Asia Pacific (excluding Japan) grew 35% over the year compared with 20% growth a quarter ago.

Microsoft’s (NASDAQ:MSFT) excellent performance in Q4 thus did not come as much of a surprise. Revenues of $16.04 billion grew 22% over the year and beat the market’s projected $15.27 billion. EPS of $0.51 was also higher than the Street’s projected $0.46. For the year, the company recorded revenue growth of 7% to $62.5 billion and EPS growth of 29% to $2.10.

By segment, for the quarter, Windows and Windows Live division revenues grew 43.5% over the year to $4.6 billion. With over 175 million copies of Windows 7 already sold, Microsoft now claims 15% of the global PC base. Server and Tools revenues rose 13.7% to $4.012 billion, driven by the growth in demand for cloud and virtualization services. Bing too maintained its growth path and hit the thirteenth consecutive month of market share growth. Online Services division revenues grew 12.8% to $0.6 billion and the Business Division grew 15% to $5.25 billion. For the month of May, Bing’s market share grew thirty basis points to reach 12.1% of the market. With Google realizing the importance of vertical search, Bing may begin to lose the vertical advantage it had over Google. Google already controls nearly 64% of the search market, and if it executes its vertical strategy well, Bing may have a tough time holding on to its own market share with the “Decision Engine” positioning.

Entertainment and Devices revenues grew 27% to $1.6 billion driven by momentum in Xbox Live, a digital marketplace offering games, music, and video downloads. Annual Xbox live digital marketplace revenues exceeded subscription revenues even as Xbox Live membership crossed 25 million subscribers. Microsoft maintained its focus on the segment and plans to launch Xbox Kinect, a motion-based controller game system, by November. While the gaming world is looking forward to the product’s release, analysts expect that the product’s $150 price tag may not appeal to users.

Despite strong revenue growth, Microsoft has missed out on the smartphone and tablet markets. Within smartphones, Apple and Google Android have taken the lead while Windows Phone 7 is still awaiting release this November. According to Gartner research, for Q1 this year the Symbian operating system commands a 44% share in the worldwide smartphone sales to end users, followed by RIM’s OS at 19% share. Both the iPhone and Android OSs have grown significantly over the past year to control 15.4% and 9.6% of the market, respectively, compared with 10.5% and 1.6% the previous year. Windows OS, on the other hand, has taken a plunge and controls just 6.8% of the market, compared with 10.2% a year ago. During the quarter, Nokia remained the market leader in mobile sales. Nokia makes both Windows and Symbian phones, and it may be a win-win idea for both Microsoft and Nokia to expand their existing alliance beyond Microsoft Office.

The smartphone market is also integrating vertically with HP acquiring Palm, thus acknowledging the fact that Windows is falling behind in the mobile space. HP is planning to use the Web OS and the Palm app store beyond smartphones in slates and Web-connected printers. HP was a key Windows-based PC maker and is now dabbling with its own OS. Within PCs, the U.S. market is still dominated by HP and Dell, both of which primarily run on Microsoft OS and control nearly 50% of the market. But Apple reported growth of 15.4% over the year to command 8.8% of the market. It looks as though the PC OS market too will be a cause of concern for Microsoft.

Finally, the tablet is a market dominated by Apple’s iPad, which sold over 3 million units in the first quarter of release. Most manufacturers are not happy with Microsoft’s tablet OS, which is highly battery intensive, leading manufacturers to switch sides. HP’s Slate, for instance, will operate on the Palm OS and Dell’s Streak will operate on Google’s Android. Even Asus is looking to adopt Android over Microsoft. Microsoft should look at tying up with Dell in the tablet market before it is too late. Apple is a vertically integrated company with products that deliver a user experience far superior to that of any other player in all three segments – PCs, smartphones, and tablets. As such, it poses stiff competition to Microsoft.

Microsoft seems to be working on regaining the lost market share with its recent announcement of a tie-up with the microchip designer, ARM. There is speculation that Microsoft may finally be working on developing its own applications processing chip for mobile devices, games consoles, and tablets. It remains to be seen how the company leverages this partnership, but as of now, I maintain my view that Apple and Google will win over Microsoft.

The stock is trading at $25.81 with a market capitalization of $226 billion. Earlier this month, it touched a 52-week low of $22.73.