Analysts: Microsoft Q4 Results Show Competitive Pressure

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Microsoft's disappointing earnings for the past quarter point to signs of damage from competitive and global economic challenges that the software vendor had until recently largely deflected, analysts said.

Microsoft Thursday reported revenue for the June quarter that was down 17 percent on net income that was down 29 percent year over year, missing analysts' forecasts. The results sent its stock price plunging more than 8 percent Friday, though it rebounded to close at US$23.45, only slightly lower than its opening price.

Microsoft's quarter proves the company, which has weathered other economic storms soundly, is not completely immune to the global economic crisis and actually may be getting hit harder than some competitors because of the scale and geographic reach of its products, said Matt Rosoff, an analyst with Directions on Microsoft.

"They're coming from a bigger base," he said. "When they fall, they fall farther."

Microsoft's results also show early effects of competitive pressure from the lower end of the markets for its two key products, Windows and Office, Rosoff said.

Netbooks, which run both Windows and Linux, are still cutting into the Windows PC market, while a 30 percent drop in consumer sales for Microsoft Office suite -- which Microsoft did not directly discuss Thursday -- could show pressure from Web-based office suites from Google and others, Rosoff said. "Pressure on the low end is certainly a factor," he said.

One thing that's been difficult for investors and analysts when it comes to predicting Microsoft's financial performance is that the company has not provided guidance about its financial situation since last October, citing economic conditions that were too unstable to predict. This in turn makes it hard for them to forecast Microsoft's performance, which made Thursday's miss so surprising, they said.

An area that's been particularly hard to read is the annuity revenue that comes from volume-licensing contracts, analysts said. Unearned revenue -- of which these revenues are a part -- was down year over year for the quarter, which threw off analyst estimates for how well Microsoft would do in the quarter, they said.

"Investor guess-timates for F4Q09 revenues that utilized F3Q09 as the base case apparently overstated the level of annuity revenues, since the annuity base has been falling as unearned revenues have been falling during the current downturn," according to a research note by FTN Equity Capital Markets Corp.

Analysts said Microsoft's reluctance to buy back shares and hoard stock during the quarter also show it may be preparing for an acquisition, or could just be hunkering down to ride out an economic environment the company expects to remain challenging.

Microsoft and Yahoo are said to be close to some kind of search tie-up, but Microsoft is not likely preparing to buy the entire company. An acquisition, then, would be of a company aside from Yahoo, they said.

"There are a lot of possibilities," Rosoff said. "They may be setting up for an acquisition, they may just be really conservative. ... Some combination of small acquisitions or maybe a larger acquisition is definitely possible. It depends on where they think their biggest weakness is."

He suggested Microsoft would serve itself well by making an acquisition in the mobile space, where Apple is still far ahead. While Microsoft floundered this quarter because of declines across its entire business, Apple reported a strong one mainly because its iPhone continues to do well, Rosoff said.

Despite Microsoft's disappointing quarter, analysts are hopeful the forthcoming Windows/Office product cycle and the commercial availability of the Windows Azure cloud platform in November, among other product launches in the next two quarters, will revive the company's growth.

"Windows 7, Windows Server 2008 R2, Bing, Xbox 360 console update and new Halo content, Office 2010, and the Azure Cloud Platform provide a platform for renewed innovation vigor beyond anything we have seen from Microsoft for multiple years," according to a note released Friday by Goldman Sachs.

The firm noted that although Microsoft is introducing a raft of products at a time when IT spending is low, the new products, combined with even a modest rebound in IT spending, could have a significant impact on boosting Microsoft revenue for the remainder of its 2010 fiscal year, which ends June 30, 2010.

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