Microsoft stumbles into crucial financial year

SEATTLE Fri Jul 6, 2012 2:09am IST

Joe Belfiore, corporate vice president of Microsoft, introduces the Windows Phone 8 mobile operating system in San Francisco, California, June 20, 2012. REUTERS/Noah Berger

Joe Belfiore, corporate vice president of Microsoft, introduces the Windows Phone 8 mobile operating system in San Francisco, California, June 20, 2012.

Credit: Reuters/Noah Berger

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SEATTLE (Reuters) - An ugly first week for Microsoft Corp's new financial year, probably its most important to date, has done little to inspire confidence that the software giant can jumpstart a stubbornly stagnant share price.

The world's largest software company, whose stock remains mired around $30, had prepared a multi-pronged assault to try and break into the crucial mobile computing space this year and take Apple Inc and Google Inc down a peg.

But on Monday, it announced a $6.2 billion writedown of a 2007 Internet-advertising acquisition - a reminder that Microsoft has a patchy track record when it ventures outside of its Windows and Office comfort zone.

Days later, Vanity Fair blamed Steve Ballmer's "astonishingly foolish" leadership for a "lost decade", in one of the most scathing articles ever written about the CEO.

It was not the news agenda Microsoft had in mind as it prepared to unveil fourth-quarter results on July 19. The writeoff is expected to hand the company its first quarterly loss - on paper - since going public in 1986.

"This kind of massive write-off is a stark reminder that Microsoft's capital allocation policies in the past have not been ideal at times," said Highmark Capital fund manager Todd Lowenstein.

Microsoft is placing several major bets over the next 12 months: its new Windows 8 operating system; its first tablets; a new version of Office; and revamped phone software.

Wall Street thinks Microsoft still stands a chance of reclaiming its former glory and investors, including Lowenstein, cite a promising pipeline for 2013. But they will want hard reasons to pay more than $30 for a stock that hasn't traded above that for any extended period of time since 2000.

"The jury is still out, but I see the potential for a renaissance here with a new platform," said Rick Sherlund, an analyst at Nomura Securities International, who has followed the company for three decades. "This is not a winner takes all, Apple kills Microsoft, death-spiral situation. There's room for a lot of innovation that allows Microsoft to grow again."

BIG CHARGE

Microsoft got off on the wrong foot with the announcement that it was writing off $6.2 billion in goodwill, chiefly for its 2007 acquisition of digital advertising firm aQuantive.

That purchase was supposed to accelerate Microsoft's entry into an online ad market dominated by Google, but it never took hold and its money-losing Bing search engine has barely dented Google's market share in the three years since launch.

The write-off was a painful admission that Microsoft has failed to make a profitable business from online ads despite growing traffic. A sale of the online unit, perhaps to Facebook Inc, would make sense now, some on Wall Street suggest.

The huge charge was not a shock to investors - Microsoft shares rose slightly in the next trading session - but it underscored how the company misjudged the Internet's commercial possibilities and lost its way in mobile computing.

Ballmer has become a lightning rod for this failure of innovation. Vanity Fair quotes one former manager saying Microsoft had turned itself into "technology's answer to Sears".

Ballmer has had critics since taking the top job in January 2000. But the widely cited thumbs-down still resonates.

"I would question how much longer he (Ballmer) will be there. That's something Wall Street is always speculating about," said a Wall Street analyst who asked not to be named. "You need someone who can manage creative talent better than Steve's done."

Some point out that Microsoft's $6.2 billion charge for an ill-conceived Internet-centric acquisition is actually better than they deserve. Ballmer offered to pay $47.5 billion for fading Internet giant Yahoo Inc in 2008. That company's market value is now less than half that.

WINDOWS 8

The central gambit for 2013 is that its touch-friendly Windows 8 software - due out around October - will fire consumers' imaginations and take root among Microsoft's core business audience.

For the first time, it will make "Surface" devices of its own to run Windows 8: a tablet based on power-efficient ARM Holdings chips to challenge Apple's iPad and an Intel Corp processor to attack the lightweight laptop market.

Analysts are skeptical Microsoft can produce a device cheaply enough to seriously threaten the iPad, but recognize that Microsoft is challenging PC makers such as Acer and Samsung to come up with better machines.

Microsoft has generated interest, but not exactly excitement about the new system, which is sure to confuse many longtime Windows users [ID:nL1E8HD00C].

But even if Windows 8 is not an instant hit, Microsoft's long-term agreements with corporations, which are paying for the latest version of Windows even if they don't use it, mean that the core Windows business will not crumble.

"Windows is not only not going to disappear, but rather become the No. 2 tablet operating system and No. 1 operating system for" tablet-notebook devices, said Mark Moerdler, a technology analyst at Bernstein Research. "In contrast to the bear case, that Windows revenue will go off a cliff."

In phone software, Microsoft has no such cushion. Despite a tie-up with handset maker Nokia, the company still has only 4 percent of the U.S. smartphone market, according to the latest figures from tech research firm Comscore.

Microsoft announced a new version of its phone software two weeks ago, called Windows Phone 8, but there are concerns that financially-squeezed Nokia may not last until its release in autumn without help. Its shares have fallen 80 percent since former Microsoft executive Stephen Elop became CEO in 2010.

"If Nokia goes away, then Windows Phone is done," said Michael Yoshikami, CEO of fund manager Destination Wealth Management, who does not own Microsoft shares. "Microsoft is either going to own or have a share of Nokia."

EARNINGS WIPE OUT

Microsoft's $6.2 billion aQuantive charge is expected to wipe out any profit for Microsoft's fourth fiscal quarter. Wall Street analysts are now predicting a quarterly net loss of $366 million when the company reports earnings on July 19, rather than its previous estimate of $5.25 billion net profit.

But the one-time charge will not affect fiscal 2013. Analysts are calling for a sales increase of about 10 percent for fiscal 2013, and profit growth of about 13 percent if the charge is discounted.

Bernstein's Moerdler thinks the share price is based on "an unrealistically bad scenario of no-to-negative perpetual growth, billions of dollars of annual cash drain from search and mobile into perpetuity, and tens of billions of dollars of additional value destruction through ill-fated acquisitions and investments."

But that is exactly what some fear. Destination Wealth Management's Yoshikami paints a worst-case scenario.

"Nokia collapses, they don't step in. They have no other significant manufacturer willing to take a chance on Windows 8, they decide they are going to take a chance on Surface tablet and that comes out at $800. Then their stock is at $28 forever."

(Reporting By Bill Rigby; Editing by Bernard Orr)

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