Microsoft: The top 5 risks; Will it cut 2009 outlook as PC market stumbles?

Microsoft: The top 5 risks; Will it cut 2009 outlook as PC market stumbles?

Summary: The worries about Microsoft's fiscal second quarter and fiscal 2009 are starting to pile up. While Microsoft is viewed as one of those recession resistant companies--no company is recession proof--the headwinds to the software giant's quarter are becoming clear.

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The worries about Microsoft's fiscal second quarter and fiscal 2009 are starting to pile up. While Microsoft is viewed as one of those recession resistant companies--no company is recession proof--the headwinds to the software giant's quarter are becoming clear.

On Thursday, Morgan Stanley analyst Adam Holt lowered his second quarter and fiscal 2009 estimates. When Microsoft reported its first quarter results it provided conservative guidance, but acknowledged that the tech spending outlook was fluid. In a CNET News interview Bob Muglia, Microsoft's server and tools chief, reiterated the company's conservative view.

Holt reckons that the PC market has unraveled since Microsoft CFO Chris Liddell delivered the company's outlook.

Holt isn't alone. Bernstein analyst Jeffrey Lindsay in a report zooms out and figures that netbooks provide a significant wild-card to Microsoft's business model on the consumer side of the equation. On the enterprise side, the biggest threat to Microsoft is software as a service. Add it up and Microsoft has some significant uncertainties ahead. Lindsay, however, thinks that the cloud computing as Microsoft killer argument is overrated. There will be a hybrid SaaS-software approach.

And as if PC demand, SaaS and other worries weren't enough Microsoft is facing tight IT budgets. Benchmark Brent Williams argues that corporate customers are likely to push back on enterprise licenses once they come up for renewal.

Add it up and Microsoft's estimates are falling fast on Wall Street. Williams shaved 6 cents a share of Microsoft's fiscal 2009 estimate to $1.99 a share. He cut his 2009 fiscal revenue estimate by $850 million to $64.6 billion.

Holt upped the ante. Holt expects fiscal 2009 earnings of $1.84 a share on revenue of $62.2 billion, down from his prior target of earnings of $2.02 a share on revenue of $64.4 billion. Wall Street is currently expecting Microsoft earnings of $1.99 a share fully reported on revenue of $64.7 billion. Holt said in a research note:

Microsoft hasn’t negatively preannounced since Dec ’00. However, business conditions have deteriorated since MSFT guided in Oct. and we believe the company could come up short of its FQ2 targets.

With that gloom and doom in mind let's examine the top concerns swirling around Microsoft.

The PC market

If Intel and AMD see their quarters unraveling what are the chances that Microsoft won't be affected? Microsoft's business still depends on the PC market to be healthy. Holt writes: 2009 will likely see a material deceleration in PC growth and longer term it will be harder for revenue to outgrow PC units. IDC is already projecting anemic PC demand of 3.8 percent in 2009.

Netbooks

The good news is that the PC market does have one growth engine--netbooks. For Microsoft, that's also the bad news. To wit: Netbooks are often powered by Linux operating systems. Microsoft is using XP in netbooks with good success. The rub: Margins on XP and netbooks are lower than full-blown Vista laptops and desktops.

Microsoft acknowledges that it doesn't know how netbooks will impact its business, but that didn't stop Lindsay from making some educated guesses. Lindsay looks at Microsoft's operating system revenue as a whole--including Windows Mobile.

Lindsay writes:

We believe that by 2012 approximately $850 million in revenues (or approximately 1% of Microsoft's expected 2012 revenues) will move to other operating systems and stacks – such as Linux, the iPhone and Android. While the shift to netbooks and mobile devices is significant, we estimate that the impact on  Microsoft's operating system franchise will be of the order of $850 million (see Exhibit 20). While up to 30% of netbooks, we think, will choose Linux to keep costs down and another 20% will go for XP rather than Vista, the impact upon the installed base and the enterprise space we think will be limited. Typically, using XP over Vista represents a saving of $30 to a manufacturer who can also get away with less processing power. In the case of Linux, which is having something of resurgence thanks to netbooks, the savings can be greater (on the order of $55 per netbook) but gives a much less satisfactory user experience.

Here are Lindsay's figures (click to enlarge):

msftrisk1.png

Office and business applications

The IT spending outlook for 2009 is anemic at best and ugly at worst. While Forrester is predicting weak IT spending in 2009 Citigroup is seeing Armageddon ahead with budgets falling as much as 10 percent to 20 percent. Citigroup analyst Ashwin Shirvaikar, who covers the services sector, notes:

Many buyers – especially in the financial services vertical – seem to be considering IT budgets that are lower year/year by as much as 10%-20%. This kind of a decrease is sharply lower than our CIO survey from September, which indicated that IT spend would be down sequentially, but still up ~1% year/year. To put this in perspective, we have had overall IT spending at flattish only once before – in 2002 – while all other years the IT budget has grown. Clearly the credit crisis and global economic slowdown – especially with sharply negative news-flow that coincided with the budget season – is a contributing factor. There are many ways to achieve this lower budget target, but reduced pricing is normally the one that gets the most attention.

You can expect Microsoft to win some business in a down market based on pricing, but it's likely that the software giant will get hit with some shrapnel.

The other wild-card: SaaS. If this downturn does push corporate buyers to SaaS, an applications model that appeals to bean counters, Microsoft's core could be threatened. Lindsay estimates that $3.6 billion (5 percent of Microsoft's projected 2012 revenue) will go to rivals pitching enterprise resource management applications enabled by SaaS.

Customer pushback

In my view, one of the biggest things to watch in 2009 will be customer-vendor negotiations. Customers, who have been milked in the name of vendor revenue growth, are going to push back. Microsoft won't be any different, but is unlikely to see the degree of animosity that SAP is facing over maintenance price hikes.

Williams writes:

We don’t believe the business from corporate customers on Enterprise Agreement term licenses will be able to throttle back the scope of those agreements or to demand price concessions on renewals at this point, which currently supports the revenue stream from the PC and Office franchises. If IT budgets are under pressure for longer than we think (we currently expect some modest recovery in software spend growth late in 2009, with full recovery trailing behind a global economic upturn by 2-3 quarters), it is possible that MSFT may face new price pressure on EA renewals than in the past, especially if Windows 7 is late or has quality issues.

Is there an online strategy?

Analysts have two takes on Microsoft's online business. On one hand the online business is a throwaway--an unprofitable unit that's sort of a sideshow. Others worry that the online business will be a distraction from the real gravy train--Windows and Office.

My hunch: If Microsoft's other businesses slip the online business will face increasing scrutiny. After all, if Microsoft really thinks advertising will mix with its software strategy someday it better get going.

Topics: Banking, Cloud, Emerging Tech, Enterprise Software, Hardware, Microsoft

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42 comments
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  • Hmmm... Agree in poart, not others.

    Over all sales are going to drop, no way the entire world can be in this situation without it hurting MS too. As far as online, I don;t think its going to matter for several years, th the internet/connectivity simply isn't reliable enough.
    No_Ax_to_Grind
    • Isn't reliable enough?

      What backwater swamp do you live in?
      spinit
      • The same as 90% of the country.

        What are you? LA scum?
        No_Ax_to_Grind
      • I agree with him

        Cell phone: Expensive data plan. Maybe former TV show host Leo Laporte can afford it, but not your average joe. Hope you're not roaming.

        WiFi: Often not free. Gotta find a hotspot.

        Airplanes: If you're lucky and rich and can afford first class. If they offer it at all.

        Pretty much the only place where I've seen reliable internet is in the house, but even that can be expensive and can have outages. And it's often not available in rural areas.

        Internet reliability is pretty much a dream right now, and as long as these companies are interested in profit (which most businesses are), it's not changing any time soon.

        This idea of "free and reliable access to the Internet everywhere" is not realistic. Not realistic at all.
        CobraA1
    • I agree with No_Ax.

      But in a different context.

      Given that our Governments and Media are so hell bent on "business, business, business", and we're "supposed" to be leading the way in the knowledge economy AND the "credit crunch" means job creation schemes, then we will surely be seeing "FREE BROADBAND FOR ALL", especially to provide talent in less privileged situations a leg up.

      Could it possibly be that the infrastructure necessary might serve us better were it more in the public domain as opposed to self interested in the name of a few who already have plenty?
      fr0thy2
      • Everything has its price.

        Sure you can do something like that.

        But everything has its price. There's no such thing as a free lunch.

        Here are the prices:

        -Higher taxes and/or larger deficit. The money has to come from somewhere.

        -A government owned monopoly, leading to a lack of choice. If it's difficult to create your own infrastructure and there is no choice but to use the infrastructure supplied by the government, then you'll have to use their infrastructure whether it's ideal for your situation or not.
        CobraA1
      • Nothing Should Be Free

        Everybody should have to pay for broadband and software and their lunch and everything else. Why do so many technology posts beg for free this and free that, all the time?

        People want things for free but they don't want to work for free. And we all agree that workers should be paid, and of course any group of workers is called a "company".

        So if people want something but they can't afford it, maybe a better approach is working and figuring out ways to increase their income so that they can afford it, rather than claiming it should be "free"?
        lmenningen
    • I also agree that network coverage is bad

      I live in NYC and in my neighborhood everyone has locked down their wifi and I am a fairly honest person so I don't try to hack into a locked hot spot. I can go to to a coffee shop but I have to haul a fairly heavy lap top and hope the battery holds out because there usually is only one public A/C plug in the coffee house.
      I can't afford a cell data plan so that option isn't available to me.

      I do often go to the library and coffee houses with several batteries in my bag so I can get internet, it is just uncomfortable and a logistical nightmare. Plus I am limited on how much I can do by my batteries.

      I wouldn't mind seeing a national WiMax network with a reasonable data plan but if it even works it is probably a few years away.

      Also in economic hardships usually the "extras" in household budgets get cut first. You don't need cable T.V. to survive, you do need food and shelter. So if you have to dump your internet and cable services to make the rent, that is usually what happens.
      mr1972
    • Your right about on-line...

      It just not there yet - one day yes...but not there yet.
      TheBottomLineIsAllThatMatters
  • Wow! Didn't know that Vista netbooks outsold both, XP and Linux.

    Neither Asus nor Acer has been selling netbooks with Vista. So, who is that mysterious market leader?
    Zukuzu
    • Vista on netbooks ?

      There is certainly a misunderstanding somewhere.
      The only Microsoft O.S available for netbooks actually is XP.Moreover besides XP and several distributions of Linux(Xandros,Linpus,Ubuntu,Suse,etc...), there are no other O.S used on netbooks.
      timiteh
      • no..

        No i have seen Vista on a netbook at Staples. they do exist
        zelrikriando
        • Was it a HP Mini note ?

          Because besides this one,though i am not even sure that it is sold somewhere else than in some asian countries,i don't see any other netbook with Windows Vista .
          There is also the HTC shift but it is not a true netbook as are not almost all sub notebook running Vista as they are far too expensive.
          Finally i have heard of upcoming netbooks running from the next year but i personnaly think that Vista is an extraordinary bad idea for a netbook.
          I like Vista much more than XP but it is definitively not adpated for netbooks or netboxes or even nettops.
          timiteh
  • Don't think that the current crisis could put Microsoft really in danger

    Even though i don't think that this current crisis would be enough to put in danger Microsoft, it has probably the potential to significantly reduce its power and its influence in the computing world.
    We will also certainly see deep changes in the computing world whom the netbooks,netboxes and nettops are only the first signs.
    It is too bad netbooks have not fully enabled Linux distributions to get as much market share as they could,thanks to the lack of concerted strategy of open source main actors, have but this crisis give them an opportunity to grow significantly.
    timiteh
    • Agreed

      I can see current times hurting MS, not fataly of course (too big, too well capitalized). I CAN see Apple, with their unjustified premium prices, loosing market share in the next year or 2. Linux should gain much ground though, being much more cost efficient solution, especially for something like netbooks, which aren't too computing intensive.

      "The views expressed here are mine and do not reflect the official opinion of my employer or the organization through which the Internet was accessed."
      gnesterenko
  • Disagreement about "Customer pushback"

    Mr. Dignan and the analyst he quotes disagree about attempts to reduce the amounts paid to Microsoft:

    Mr. Dignan:

    In my view, one of the biggest things to watch in 2009 will be customer-vendor negotiations. Customers, who have been milked in the name of vendor revenue growth, are going to push back. Microsoft won???t be any different

    [End quote]

    The quoted Williams:

    We don???t believe the business from corporate customers on Enterprise Agreement term licenses will be able to throttle back the scope of those agreements or to demand price concessions on renewals at this point, which currently supports the revenue stream from the PC and Office franchises.

    [End quote]


    I think Mr. Williams is more likely to be correct because of the expectation that Windows and Office are ordinary expenses.
    Anton Philidor
    • Enterprise Agreements

      Not to mention that if your business is setup using Windows Enterprise systems for backend, if you don't renew your agreement, you business pretty much becomes stagnant.
      NCWeber
  • Left out the main issue.

    The industry relies on new versions of Windows to sell hardware. Remember the disappoinment when Vista was not available to help assure good Christmas sales.

    Perhaps the reason Vista SE has been worked on so intensely is the hope that the computer industry in general can be rescued by Microsoft.

    So the main issue is, can Microsoft once again save the industry?
    Anton Philidor
    • You are right here..

      But it's the industry they themselves designed.

      Better question would have been: Is the IT industry in it's current design a durable longterm selfsustaining venture?
      TedKraan
    • even Chrysler did better

      Back in the old days the car companies at least made their own tail fins to lure customers. Why can't intel, AMD , etc simply tweak a linux distro to run best on their platforms?
      j5n