Microsoft Scores With Kinect But Needs A Tablet Strategy

According to Gartner, global personal computer shipments in the quarter ended December 2010 increased 3.1% over the year to 93.5 million units, falling short of the anticipated 4.8% growth for the period. Gartner attributed this lower-than-expected growth rate to rising competition in the form of tablets and other devices such as game consoles. For the same period, IDC reported that worldwide PC market increased a modest 2.7% over the year. The report claims that total shipments for 2010 increased 13.6% over the year to 346.2 million units.

Microsoft’s Financials
Microsoft’s (NASDAQ:MSFT) Q2 revenues grew 5% over the year to $19.95 billion and were significantly higher than the market’s estimated $19.15 billion. Total bookings grew 21%, marking the third consecutive quarter of more than 20% growth. The company saw strong growth in the entertainment division, driven by better-than-expected sales of Kinect, a motion-based game system that attaches to Xbox and was released in November of last year. Entertainment division revenues grew 55% over the year to $3.7 billion. The Business division, which includes Office, also saw revenues grow by an impressive 24% over the year to $6 billion. Higher tablet sales hurt Windows revenues, which fell 20% over the year to $5.1 billion. The Online division’s revenues grew 19% over the year to $0.7 billion. Server and Tools saw revenues grow 11% to $4.4 billion.

EPS for the quarter came in at $0.77 compared with $0.74 earned a year ago. The market was expecting EPS of $0.68.

Microsoft and the Tablet Market
According to IDC research, 8.9 million tablets were sold last quarter. Apple’s quarterly release claimed that it sold 7.33 million iPads last quarter. The numbers may still be insignificant compared with the 93.5 million PCs shipped last quarter and the close to 300 million Windows 7 licenses sold to date. But the growing tablet market is a cause of concern for Microsoft, which still relies on PC sales for the Windows division.

Microsoft’s failings in the tablet market can also be seen in the recently released tablets by Asus. Of the four touchscreen tablets released, three were powered by Android and were priced from $399–$499, close to the iPad’s $499 price tag. However, the Windows 7–powered tablet was $999. To address this problem, Microsoft realizes the need to rewrite Windows to make it more suitable for a tablet. The company has announced it is gearing to release a version of Windows on devices that are powered by ARM-based processors. The new Windows version is expected to be customized for battery-powered devices such as tablets.

Microsoft and the Mobile Market
Microsoft isn’t faring any better in the mobile market. According to Gartner, worldwide mobile phone sales grew 35% over the year to 417 million units in the third quarter of 2010. Smartphone sales grew 96% over the year and accounted for 19.3% of overall mobile phone sales in the quarter. The report claims that Microsoft’s share of the smartphone operating-system market declined to 2.8% in the third quarter, from 7.9% a year ago. Meanwhile, Android’s share increased to 25.5% from 3.5%, while Apple’s iOS share declined to 16.7% from 17.1%. But Apple iOS is finally ahead of RIM, whose share fell from 20.7% a year ago to 14.8%.

During the previous quarter, Microsoft released Windows Phone 7. However, the launch may have come a bit too late. According to Microsoft, it shipped 2 million licenses for the software, which has been deployed on nine devices with 60 operators in 30 markets. But that number is a far cry from Apple’s 16.2 million iPhones sold in the same quarter.

I still believe that for Microsoft needs to make some big acquisitions for a winning position in the mobile phone market. Nokia, with its market leadership with 28% mobile market share, and Research in Motion are potentially good acquisitions.

Microsoft’s Kinect
While Microsoft may be struggling in other departments, the company does seem to have a good product in Kinect. Kinect has become one of the fastest-selling consumer products around and recorded more than 8 million unit sales in the first 60 days of its launch. It was named as one of the hottest products for the Christmas season this year and has been described as changing the console gaming scenario by eliminating the need for physical game controllers with buttons and enabling users to activate the game with hand movements and voice commands. Microsoft’s Xbox currently commands 17% of the console gaming market, a number that Kindle will surely help to increase.

The company is now working on newer features for the motion-sensor game that attaches to the Xbox 360 console. Until now, the game let players use gesture and voice commands for movies and videos found in Microsoft’s Zune on-demand marketplace. Kinect users will now be able to use those same commands to view and control playback of videos on Netflix and Hulu Plus on Xbox Live. Microsoft is also introducing “Avatar Kinect,” a new title on Xbox Live that lets users host their own talk shows through Xbox Live avatars. The title will track users’ facial expressions, record their avatars in different settings chatting together in a virtual space, and even share videos online.

The stock is trading at $27.73 with a market capitalization of $233 billion. In July of last year, it touched a 52-week low of $22.73.