Analyzing Microsoft (MSFT)
By Yaser Anwar, CSC of Equity Investment Ideas
On November 30th MSFT released Windows Vista operating system after tons of delays and glitches- so what does this mean for shareholders? After all the delays and glitches in Vista and the new product cycle, The Street is expecting it to be a compelling 1.
In my view the new versions of Vista and Office 07 software, scheduled to be introduced in 07, will contribute to more notable growth in the 2nd half. For 07, MSFT sees 8% to 10% growth in worldwide PC unit shipments, and a 10% to 12% increase in servers. The Street’s current assumptions for Vista’s uptake and pricing already put 08 EPS consensus estimates of above $0.04 above consensus expectation.
Before I go on further let’s take a look at tech spending- Investors should look for 07 IT spending growth to be similar to 06, in the range of 6%-7%. Technology spending is now so entiwned with the overall macro picture (i.e. slowing economy & co.) that it makes it difficult to imagine IT spending accelerating in the face of anticipated deceleration in consumer expenditures and business spending.
According to IDC, global spending on packaged software totaled $211+ bn in 05, with MSFT’s share totaling $35 bn, 17% of the total market. IDC expects the system infrastructure market, which comprises roughly half of MSFT’s software revenues, to grow at a compound annual growth rate CAGR of 9.1% from 05 through 2010. The applications market, which counts for more than a 1/3rd of revenues, is expected to increase 7.0%, and the application development and deployment market, more than 10% of revenues, is expected to expand 7%
Let’s take a look MSFT’s consumer business divisions- MSFT management expects the consumer business division to turn profitable for the year in 08, requiring a $1+ billion improvement in the P&L. MSFT expects the Xbox business to turn profitable, then will focus on Zune (not so sure about Zune succeeding given the lackluster "buzz", if I may say, around it), while the Mobile & Embedded and Consumer Products businesses are profitable.
One question I always find asking myself is why are the making all these Xboxs and other consumer products when they loose money hand over fist? After digging deeper I’ve found that these businesses are strategic, in that they may provide a connective entertainment platform for the consumer [read: Xbox Live & Boston Consulting Group’s growth share matrix].
Diversification is another reason. MSF can leverage the digital technology as it continues to evolve in the consumer segment. They can provide incremental earnings, so profitability is a goal (Profitability is a goal? really? the way they were bleeding $$$ I kind of thought they did it for free! just kidding). On a more serious note these businesses also act as competitive tools to offset or check major rivals in businesses that can accommodate more than just one major vender.
Coming back to Vista- There was so much buzz about Vista but now that its released does it still exist? I think its died down a bit but then again I don’t really have a technology network of connections to give me the proper view. So what to do? Be skeptical until proven otherwise. Investors should do not expect the uptake of the operating system to be as rapid as that of the "revolutionary" Windows 95, but it should be faster than that of subsequent, more incremental operating systems such as Windows XP.
The Street assumes that 29-35% of the PC installed base will be running Vista by the end of 08 and that 51% will be running Vista by the end of 09. Higher adoption rates (35% in 08 and 56% in 09) would add significantly to EPS- $0.04 in 08 and $0.06 in 09.
The penetration rates may seem a little high but historically these rates are achievable. I’m expecting Vista’s adoption rate to be somewhat similar to XP’s, where the earliest stages of the cycle are driven by consumers and with a longer, more sustainable corporate cycle kicking in upon the release of service packs.
Given the 23% rise since July in MSFT, I’m concerned that the Vista cycle is fully reflected in the company’s share price. To the contrary The Street believes that the potential for Vista-driven revenue upside still exists.
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