Microsoft Earnings Outlook: Pushing Hard to Compete Despite Industry Change

Investing, Investments

In an era of tablets and smartphones, what is a company like Microsoft to do?

Compete harder, that’s what.

Microsoft (MSFT) will announce its quarterly results on Thursday, October 18th. News about corporate strategy and future guidance is eagerly anticipated while lackluster sales and earnings from the last quarter will not surprise anyone in light of low analyst estimates. Microsoft’s next moves in the consumer computing market are a subject of considerable interest and they will upstage recent results.

Quarterly Decline Expected by Analysts

The average analyst estimate for Microsoft’s 2012 third calendar quarter earnings is $0.56 per share. Analyst estimates for earnings range between $0.47 and $0.64 per share, but they are consistently lower than the third calendar quarter of 2011 which saw earnings of $0.68 per share. Analysts also expect quarterly sales for Microsoft to be down year-over-year. Sales estimates range from $16.00 billion to $16.87 billion with an average of $16.45 billion. All of these estimates are lower than the $17.37 billion of sales recognized this time last year.

Microsoft’s Many Segments

Analyst estimates incorporate how the decline in personal computer sales has decimated the distribution of Microsoft’s Windows and Office software products. This is collateral damage from the popularity of mobile devices like tablets and smartphones which often function as substitutes for laptop and desktop PCs.

Though this is a revolutionary trend in the computing market, it is not really news. Trends in the company’s different business units reveal how these changes have impacted Microsoft over the past two years:

Revenue ($ Millions)

2012

2011

2010

Microsoft Business

  23,991

  22,514

  19,256

Server and Tools

  18,686

  16,680

  15,109

Windows & Windows Live

  18,373

  19,033

  19,491

Entertainment and Devices

  9,593

  8,915

  6,079

Online Services

   2,867

   2,607

   2,294

 

Operating Income ($ Millions)

2012

2011

2010

Microsoft Business

15,719

14,657

11,849

Windows & Windows Live

11,460

12,211

12,895

Server and Tools

7,431

6,290

5,381

Entertainment and Devices

364

1,257

517

Online Services

-8,121

12,657

-2,408

Corporate-Level Activity

  -5,090

  -4,597

  -4,136

Microsoft’s Windows & Windows Live segment has been in decline since fiscal 2010. (Microsoft has a fiscal year which ends in June.) Both operating income and revenues from this segment have dropped over the past two years. In contrast, Microsoft has seen improving results from its two business-oriented segments: its Microsoft Business unit and its Server and Tools unit. This substantiates the idea that Microsoft is becoming a business solutions company like IBM (IBM).

Since the market expects a continuation of this trend, it is primarily interested in Microsoft’s Entertainment and Devices unit and in its Online Services unit.

Microsoft vs. Competitors: This Time It’s Personal (Computing)

Microsoft’s Entertainment and Devices segment and its Online Services segment are lagging its other businesses. Worse yet, Web 2.0 services and mobile devices are incredibly hot sources of growth in other companies. Thus, improvements to these segments represent a turnaround opportunity for Microsoft.  Critically, Microsoft is working to “reinvent the tablet” with its new Surface launching.

Microsoft’s strategy for retail personal computing has seen interesting developments and is also the subject of speculation. Microsoft CEO Steve Ballmer has said that Microsoft will take a more active role in providing cloud services and mobile devices that will compete against Apple. In this vein, Microsoft has announced that it will provide a streaming music service through its Xbox console which will compete with Pandora (P), Amazon (AMZN), Apple’s iTunes, and Google (GOOG) music offerings.

The departure of Reed Hastings from Microsoft’s board of directors has inspired rumors of Microsoft entering the streaming video content market as well. Such a development would make sense since Microsoft’s Xbox console can be used to access the Netflix (NFLX) streaming service. Other speculation includes collaboration with Research In Motion (RIMM).

What to Expect Thursday

The quarterly announcement will probably reveal lackluster sales and earnings results while clarifying Microsoft’s vision for future growth. Expect Windows & Windows Live revenues to decline and for its business segments to stagnate as corporations delay capital expenditures given tepid economic expectations. You should also expect more information about what services Microsoft hopes to rollout for retail consumers by the holiday season.