Microsoft announced its latest quarterly earnings on Thursday last week. The earnings came in two cents below expectations at 28 cents per share for the quarter. For the year, Microsoft earned 1.12 dollars per share. Microsoft is expecting earnings of 1.45 dollars per share next year a rise of almost 30% year over year.
So the question is - is this a good buying opportunity or is it a time to avoid this stock? Microsoft has always promised big but has come short of late. We will look at some fundamental factors impacting the business which hopefully will lead to the conclusion without needing any further analysis.
The windows client business tracks directly to the growth in PC shipments and is growing in high single digits/low double digits. The office business is mature and is growing in mid single digits. The windows server and tools division is growing much faster in mid teens. All the emerging businesses are barely breaking even or making losses. Particularly, the xbox business lost about 1.3 billion this year. It remains to be seen if the situation will get better in the coming fiscal year. The MSN division is expected to do better in the coming year with 7-8% revenue growth compared to this year where the revenue has slid compared to last year. However, this division is likely turn significantly to the red with additional spending of 500 million dollars in the next fiscal year. Microsoft's headcount increased by 18% this year compared to the previous year. The headcount related costs increased much faster than revenue and is likely to keep increasing at a fast pace in the next year.
The windows grip on the OS market is likely to continue to grow for the next five years. In addition, the windows server is also showing impressive top line growth in the mid teens and is expected to continue this growth in the coming year and it is unlikely that one will see drop in the server market share in the next three-five years. The big question mark is MSN and Entertainment and Devices teams. Although it is likely that these divisions will make some progress, it is unlikely to translate into better bottomline within the next three years. MSN in particular seems set to spend more than a billion with revenues in the 600 million plus mark - it is unlikely this shortfall will be bridged in the next three-five years.
The 20 billion dollar stock buy back in a dutch auction is a good thing as it forces better fiscal discipline on the company. It is likely that the company will buy back about 8% of its shares back. The impact of this buy back is reduced by extra dilution through stock grants. From the companies earning expectations - it looks as though the impact of the dilution is 100-250 million stocks next year. In addition, it is likely that 1-2 billion dollars will be spent in legal settlements and the like resulting in special charges.
The company enjoys profit margins of 33 cents a share despite all the extraneous spending and a margins of 44 cents a share without the home and entertainment division. The margins would be even higher without MSN. MSN, home and entertainment breaking even would make the profit margins immensely better at Microsoft.
While the windows franchise seems safe for the next five years, it is not clear how the technological landscape will look like in another ten years. Microsoft definitely has the financial capacity to power into any market but with four out of the seven divisions unprofitable/barely profitable, even Microsoft's ability to invest and compete in new areas seem somewhat limited.
Microsoft clearly has the potential to do well. However, it is difficult to put the odds in favor of Microsoft at the moment. The next financial year should give a clearer indication of how things will turn out in the coming years. It seems a good bet to stay on the sidelines till then.