Can Windows Phone 7 Change The Smartphone Game?

IDC’s Worldwide Quarterly PC tracker released for Q3 saw 10.5% growth in PC sales compared with the 14% projected for the quarter. Weaker-than-expected growth was driven by weak consumer spending in the United States, where PC shipments grew a mere 3.8% over the year compared with the 11% projected. Only Apple saw better-than-expected sales in the U.S., primarily on account of its iPad. Over the year, Apple recorded 24% growth in PC shipments, and the company moved to the third position in the U.S market. But despite Apple’s continued growth, Microsoft (NASDAQ: MSFT) does not seem to be worried about their Windows division and claims to be confident that tablets “will expand the PC market” and will “bring Windows to additional form factors and new usage scenario.”

Microsoft’s Financials
Quieting the market’s concerns on their performance amid the growing iPad market, Microsoft delivered a stellar performance. Q1 revenues of $16.2 billion and EPS of $0.62 were significantly ahead of market projections of revenues of $15.8 billion with EPS of $0.55.

Revenues grew 25% over the year driven by double-digit growth across all divisions. The company saw their biggest growth in Entertainment and Devices revenues, which grew 27% over the year driven by 38% growth in Xbox units sold in the period. Xbox sales were driven by the release of the latest installment of Halo, an alien shooting game. The game had $200 million in sales on its first day alone, making it the biggest opening day for any movie or game released this year.

Microsoft’s business divisions grew 14% over the year, driven by the expansion of cloud services. They claim to have tripled the number of business customers in the cloud within the past year. Recently, they announced the launch of the next generation of their cloud productivity service, Office 365, which brings together Lync, SharePoint, Exchange, and Office Professional, plus Desktop software, in the cloud.

Within online, they are on track with their search agreement with Yahoo! and during the quarter, Yahoo! started using Microsoft’s Bing search technology to power queries. Bing’s search share saw a minor increase to 11.2% in September from 11.1% in August. Overall, online revenues grew 13% over the year but continued to suffer losses.

The Server and Tools division grew 12%. Beating the market’s worries that the iPad may outshine Windows demand, the Windows division reported 10% growth over the year. Windows 7 has sold a record-breaking 240 million copies since its launch over a year ago.

Microsoft projects fiscal 2011 revenues to be $26.9 billion–$27.3 billion.

Microsoft’s Windows Phone 7
Microsoft’s big concerns for now is the smartphone market, which at present is relying on the Windows Phone 7. The phone OS launched in Europe and Asia last week and is scheduled for launch in the coming week in the United States. It is expected to be available worldwide on over 20 phones by this Christmas. The OS has received good initial reviews, some saying that Microsoft has gone beyond the smartphone norm by designing a screen with colorful rectangles called “live tiles” instead of icons. These tiles provide information at a glance, such as the phone log, and link to frequently used programs. Further, the Phone OS will be organized around “hubs,” which are a collection of programs, information, and functions based on one of their six themes – People, Pictures, Music & Videos, Marketplace, Microsoft Office, and Games.

But it may still be a case of doing too little, too late. According to market studies earlier this year, Google and Apple have already taken a big lead in the market, with Android holding a 16.3% market share and Apple another 14.7%. Microsoft followed Apple with a mere 6.8% market share. I believe that it will be a tough battle for Microsoft to win, and it needs more than the Windows Phone 7.

Microsoft ended the quarter with over $44 billion in cash and equivalents and they should be looking at investing some of that money in acquiring bigger smartphone players like Nokia or Research in Motion (NASDAQ: RIMM). Nokia’s recently appointed new CEO, Stephen Elop, is expected to focus on the North American market. Further, as Symbian’s market share continues to decline, Windows Phone 7 may offer Nokia the big push that it needs. Also, Nokia will bring with it leadership in the mobile device market, a position that Microsoft will not be able to reach on its own. Research in Motion could be another potential acquisition as it too continues to struggle with declining market shares despite a distribution channel and a strong position in the enterprise mobile market. Also, adding a hardware device to their portfolio will help Microsoft control the end-to-end user experience for smartphones – a model that has clearly worked for Apple.

Microsoft’s stock is trading at $26.76 with a market capitalization of $232 billion. In April of this year, it touched a 52-week high of $31.58.