By Megan Barnett
July 19, 2010

After living in the shadows of Microsoft for 30 years, Apple is just a hair behind Microsoft in sales. Will this quarter be the one?

by Andy M. Zaky, contributor

Whether it deserves it or not, Apple has held onto its lead over Microsoft in terms of market capitalization since it first surpassed it back in May. While it may be bigger in value thanks to a meteoric stock surge, Apple’s revenue and earnings still fall short compared to Microsoft. But that’s all about to change.

Apple will report second quarter earnings on Tuesday, and Microsoft will follow on Thursday. Though Apple still has a ways to go to compete with Microsoft in terms of net income due to Microsoft’s untouchable operating margin, many will be surprised to discover that Apple’s revenues are close to surpassing Microsoft’s. If it doesn’t happen this week, it will almost certainly come in the next quarterly announcement.

It’s important to step back and examine just how close each of these companies really are in terms of revenue and earnings. Analysts polled by Thomson Reuters expect Apple to report approximately $2.85 billion in net income ($3.07 in EPS) on about $14.62 billion in revenue when it releases results after the bell on Tuesday.

Yet, it’s well known that Apple regularly beats consensus estimates by quite a large margin and that actual results will come in well above the consensus.  Just last quarter, Apple not only beat revenue estimates by over $1 billion, but it annihilated EPS estimates by reporting $0.88 above the $2.45 consensus – a 36% beat. In fact, Apple has regularly beaten consensus estimates by well over 35% each quarter over the past year.

Financial Alchemist’s Turley Muller, who is currently the most accurate analyst on Apple, offers a more realistic view of the company. Muller believes that Apple will report about $3.1 billion in net income on ($3.35 in EPS) on $15.15 billion in revenue. And while I think Muller has left some room for upside surprise, it’s clearly best to use his numbers rather than the consensus as a measure of comparison.

Microsoft, on the other hand, is expected to earn $4.1 billion in net income ($0.46 in EPS) on $15.26 billion in revenue when it releases results on Thursday – just a hair above Muller’s revenue estimates for Apple. And while Microsoft regularly reports upside surprises itself, the gap between consensus estimates and Microsoft’s actual results is nowhere near as wide as it is with Apple’s results.

Thus, if Apple reports at the higher end of Muller’s estimates, and if Microsoft reports closer to the consensus, it’s quite possible that Apple might have a shot to beat Microsoft in revenue for the first time in its history this quarter.

The chart below details a quarterly revenue comparison of Apple and Microsoft over the past few years. As one can see from the chart, Apple is within striking distance of surpassing Microsoft’s quarterly revenue. Since Microsoft and Apple are on a different fiscal year, the chart realigns their results based on the calendar year.

So the big story in tech earnings this week is whether history will be made in the decades-long battle between Apple and Microsoft, or whether Microsoft will postpone the inevitable and maintain its dominance over Apple for at least one more quarter.

Even if Apple doesn’t beat Microsoft in sales this quarter, it will almost certainly do so next quarter and by quite a large margin. For the September quarter, analysts expect Apple to generate approximately $16.81 billion in revenue compared to a projected $15.16 billion in revenue for Microsoft.

So even conservative estimates, which have yet to be adjusted to account for iPad sales, already put Apple ahead of Microsoft by nearly $1.2 billion next quarter. My estimates put Apple ahead by $3.2 billion as I expect Apple to record nearly $18.9 billion in revenue.

What’s even more surprising is that Apple will likely far surpass Microsoft in revenue for the entire 2011 fiscal year. I’m looking for Apple to record $81.6 billion in revenue, well above the $70 billion I’m expecting out of Microsoft for the year.  You can view my track record on Apple at Philip Elmer-DeWitt’s column Apple 2.0.

Even the analyst consensus puts Apple well ahead of Microsoft next year, with revenue estimates of $72.6 billion (AAPL) versus $67 billion (MSFT). The chart below compares Apple and Microsoft’s annual fiscal revenue for the past several years.  While quarterly data must be compared on the calendar year to show a side by side comparison over a particular 3-month period, yearly data can be analyzed on the fiscal year.

And what about other metrics? Net income growth, total net income, total net cash, cash flow, book value, total assets and the economic sensitivity of each company’s primary operations are a just a few of the other key factors to consider when comparing the two companies.

While Apple will surpass Microsoft in revenue in the near future, that doesn’t necessarily mean that Apple automatically deserves a larger market capitalization. But it does appear that Apple will not only record more revenue than Microsoft, it will also eventually (within the next few years) earn more in net income, generate a larger amount of cash, and outpace Microsoft in terms of growth in net income and revenue.

The earnings beat won’t come easy for Apple. Due to Microsoft’s extraordinarily high operating margin, the only way Apple will beat Microsoft in earnings is by simply outpacing it in sales. Since Microsoft pushes more of its revenue to the bottom line, Apple will have to significantly outpace Microsoft in revenue to win on the net income front. The chart below compares Apple and Microsoft’s net income for the last several fiscal years.

Though these two companies no longer really operate in the same space as they once did with Apple turning its focus on the consumer and Microsoft on enterprise spending, both companies are dominating their respective industries. The question that remains is which of these two tech giants deserves to be crowned the supreme leader of the tech sector as a whole?

The answer to that question will be addressed in future articles I’ll be writing over the next few weeks. Stay tuned.

Update 7/20: As expected, Apple has once again crushed the consensus estimates on the top line, beating analyst revenue expectations by over well $1 billion when it reported $15.7 billion in revenue Tuesday afternoon.  In fact, Apple even surpassed my lofty expectations of $15.6 billion by $100 million in sales. Unless Microsoft far surpasses analyst expectations of $15.24 billion in revenue, it appears that Apple has already won the race.

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