| Microsoft stock has crept higher since it sank three months ago on word of its Yahoo bid. |
Can Microsoft do it again?
Late last year, investors and analysts were wringing their hands over a tech stock collapse. With the economy starting to slow, investors punished a slew of big techs including Microsoft (MSFT), IBM (IBM) and Hewlett-Packard (HPQ). Not even hot-growth companies like Apple (AAPL) and Research in Motion (RIMM) were spared.
Then Microsoft reported earnings in January, and the sun came out: $6.5 billion in profit for the holiday quarter on sales of $16.4 billion. And best of all, the forecast was bright. “We actually feel very optimistic,” said Microsoft Chief Financial Officer Chris Liddell. “The next six months we feel very good about.”
Some tech stocks have since been released from detention as a result. IBM and HP have rebounded from their lows and the sense of panic in tech has dissipated. Now, the spotlight is back on Microsoft as it prepares to release its fiscal-third quarter earnings on Thursday. And the stakes for the software giant are even higher.
The company continues to take heat for the tech market’s less-than-enthusiastic reception to its Windows Vista operating system. There are signs that corporate customers could cut back on tech spending during the remainder of the year. And perhaps most significantly, Yahoo (YHOO), the online property Microsoft has sought to acquire since February, reported earnings this week that narrowly beat analyst estimates, increasing the likelihood that Microsoft will have to offer more money to seal the deal.
With all that in mind, Microsoft’s stock is down nearly 5% since its last earnings report and is trading more than 15% below its 52-week high. Here’s what Microsoft must do to restore some faith in the company’s strategy:
First, it needs to make its numbers, and hint at a strong fiscal 2009, which will begin this July. Wall Street is expecting a profit of 44 cents per share on revenue of $14.5 billion for the third-quarter, with a few prominent analysts expecting a little upside on the profit side.
Charles Di Bona of Bernstein Research, for example, is looking for profit of 45 cents a share. For fiscal ’09, Di Bona wants to see profits of $2.16 per share on revenue of $66.65 billion, both a tad higher than current consensus estimates. Di Bona wrote in a report that investors are underestimating how strong future sales and profits from Vista will be.
Microsoft also needs to show strength in Windows and Office sales, which should be easy since global PC shipments this year have held up better than many in the industry expected. Analysts will be paying particularly close attention to business adoption patterns for Vista and for server software, which has been showing healthy growth.
If adoption of Vista remains weak among businesses, it will undermine the thesis of Di Bona and others who believe it’s only a matter of time before IT departments upgrade to Vista.
Finally, Microsoft will need to show some strength in its online unit. Despite worries that the online ad market has been crumbling this year in a weaker U.S. economy, Google (GOOG) beat revenue and earnings estimates when it announced its first-quarter results last week.
Microsoft has bolstered its online services business division through last year’s acquisition of online ad firm aQuantive. Sales in the online services unit grew nearly 40% from a year ago in Microsoft’s fiscal second-quarter. But the division still posted an operating loss of $245 million.
If Microsoft’s online division does not perform well, it could embolden those who say that Microsoft needs Yahoo to compete with Google and that it should be willing to raise its bid if Yahoo doesn’t give in before Microsoft’s Saturday deadline to Yahoo to accept the offer.
So what are the chances of Microsoft getting everything right? Not as good as they were three months ago. Sure, PC sales have remained stronger than expected so far in 2008. And with Vista, the company has done a better job keeping piracy rates lower.
But because much of the strength in PC sales has been overseas, there’s a possibility that Microsoft’s profit margins won’t be as strong as investors hope. Of particular concern are business customers. Did they keep up their software-buying spree, or did they begin showing some timidity, as IBM noted recently?
We’ll know shortly. After that, we’ll see if investors can keep their cool.