Microsoft Bucks the Tech Trend

Pessimists expecting signs of a tech slowdown didn't find what they were looking for in Microsoft's strong second-quarter earnings

by Aaron Ricadela

Microsoft chief executive, Steve Ballmer Getty Images

Investors bruised by this year's tech-stock rout found a balm in Microsoft's fiscal second-quarter results released on Jan. 24. It wasn't the blockbuster results that Microsoft (MSFT) reported in October, but sales surpassed analyst expectations nonetheless, and the company raised financial forecasts for the rest of the fiscal year. That was good enough for shareholders who have been scouring results from every bellwether for signs that the economic slowdown is damping tech demand.

They found scant evidence in Microsoft's numbers. In the quarter ended Dec. 31, profit jumped 79%, to $4.71 billion, or 50¢ a share, as sales climbed 30%, to $16.37 billion. Analysts had expected earnings to increase 66%, to $4.35 billion, or 46¢ a share, on a 27% increase in revenue. Results were bolstered by a combination of strong PC sales, upgrades to Microsoft's most popular products, and the relative safety of its international business. Microsoft also benefited from the deferral of $1.6 billion in revenue from its December, 2006, quarter, when it gave customers coupons for new versions of its Windows operating system and Office productivity package, aimed at business users. Not counting that gain, revenue still rose 15%.

The company followed a tough act in the September quarter, when Microsoft blew past revenue expectations (BusinessWeek.com, 10/26/07) by $1.3 billion, causing its stock to reach a five-year high. "You have to look really hard to find any weakness in our results from the first half," Chief Financial Officer Chris Liddell said during a conference call with investors. "We haven't seen any spillover to our business" from the economic slowdown affecting U.S. companies, he added. More than 60% of Microsoft's sales are to customers outside the U.S. "We expect the overall software spending environment to remain healthy," Liddell said.

A Strong Place to Camp Out

Microsoft isn't immune to a further worsening in the economy, but for now its stock could be a safe haven in a sector that's already feeling the fallout from economic slowing. "Everyone's so concerned about the macro condition, and software is typically a lagging indicator," says Brent Thill, director of software research at Citigroup (C), who forecasts shares of Microsoft will reach $41 within a year. "This is the biggest single issue for the stock right now," says Thill, who has a buy rating on the shares, even though he's advising clients to tread lightly in software stocks. He points to Microsoft's slate of upcoming products, low prices, and international diversity as reasons why "Microsoft is a relatively stronger place to camp out."

Some investors concur. Shares of Microsoft rose more than 4% in extended trading, after the results were released. That built on a 4.1% increase, to $33.25, in regular trading. The shares are down 6.6% since the beginning of the year, compared with an 11% drop for the Nasdaq composite index.

Why are analysts bullish? For starters, new products could spur growth. An update to Vista, the latest iteration of Microsoft's operating system, may make the system more palatable for corporations. And the company is slated to launch new versions of its Windows server, database, and development tools software on Feb. 27. Analysts also point to a pristine balance sheet that shows $21 billion in cash, no long-term debt, and $12.2 billion in unearned revenue from long-term licensing deals to be recorded in coming quarters. Microsoft also has been repurchasing shares, buoying its stock price.