Microsoft Stretched in Multiple Directions

Microsoft (MSFT) announced their Q3 results yesterday. While their revenue for the quarter of $14.5 billion met market expectations, their EPS of $0.47 exceeded the street’s views of $0.45. The revenue for the quarter reported an increase of 14% over the previous year while the EPS reduced by 6% from $0.50 in the previous year Q3.

Segment wise, client revenue was down 24% to $4.0 billion, server and tools revenue was up 18% to $3.3 billion, Microsoft business division revenue was down 2% to $4.7 billion, Entertainment and devices division revenue grew by an impressive 68% to $1.6 billion and Online services business grew by 40% to $0.8 billion. Forbes details the Entertainment and Devices(XBox business) out.

For the fourth quarter, they are giving a guidance of $15.5-$15.8 billion or a 16%-18% growth over the year with an EPS of $0.45-$0.48. This would take their fiscal 2008 revenues to $60.1-$60.3 billion, representing an annual 17%-18% growth and EPS of $1.87-$1.90, representing a 33%-35% growth over the year.

For the fiscal 2009, they are projecting an 11%-13% growth in revenue to $66.9-$68.0 billion. The EPS is expected to grow 14%-15% to $2.13-$2.19 for the year.

Despite tough economic conditions in the US, the company has been able to show and give an outlook of substantial growth primarily due to its ability to hedge its country risks. Two-thirds of the company’s revenue comes from outside the US and 15% of the international revenue is generated from emerging markets.

Online is a whole other issue. Microsoft believes in an expensive growth strategy. They end up acquiring or investing in all the online verticals, see what works and then expand. Microsoft, with its huge stash of cash, can afford to play this game, but it is not going to guarantee future success. The gaps are depth-oriented, not breadth-oriented. Furthermore, Microsoft’s main strength in business software, in my opinion, is a far better place to spend its cash reserves, not in the online businesses, where its core competency is limited. But, now that the Yahoo! acquisition battle is well under way, this will all change. As I said earlier, building depth in verticals such as Travel (which they are doing, as evidenced in the acquisition of Farecast), is a smart strategy. Yahoo is not strong in travel, and Farecast will complement the Yahoo portfolio when it becomes a part of Microsoft, even though Henry Blodget says it may not.

The current quarter also saw a bunch of smaller acquisitions. Microsoft acquired Caligari for collaborative 3D modeling, YaData for customer micro segment management, Rapt for behavioral targeting, FAST Search and Transfer to enhance their enterprise search offerings and Danger, a mobile handset vendor. Danger, most of all, is their hedge in the vertical integration trends brewing with Apple’s presence in Mobile Handset, OS, Applications, and now chips. How far are we from a day when Microsoft will be in chips?

The stock did not show major reactions to the results. Earlier last month, it had reached a new 52 week low of $26.87 and was up 18% to $31.80 at yesterday’s close. This morning, it is trading in the $29.60-$30.39 range.