Investors Pummel Microsoft; IBM Impresses

Despite strong sales of Vista, an unexpected boost in spending on online operations sent Microsoft's stock reeling in after-hours trading

by Jay Greene

Just as Microsoft allayed one set of fears with its fourth-quarter earnings results on July 17, it inflamed a new one. Wall Street headed into the report fretting that Microsoft might turn in a second straight quarter of lackluster demand for its flagship operating system software. The software giant put those concerns to rest with better-than-expected sales of Microsoft Vista. But unexpected new investment in online operations, coupled with increased costs that led Microsoft to miss its earnings target, pummeled the stock.

Redmond (Wash.)-based Microsoft (MSFT) said earnings in the period ending in June rose to 46¢ a share, falling short of its forecast by a penny. The company then reduced forecasts for 2009 earnings, in part because of plans to increase operating expenses by $500 million. Microsoft has earmarked most of that money for its online efforts. Analysts say the investment is needed, but remain dissatisfied with results of spending to date. "They've already had a lot of money built in" to capital spending plans, says Charles J. Di Bona, an analyst with Sanford C. Bernstein. "How much more can they spend?"

Microsoft has never laid out expectations for its online unit to become profitable, and Chief Financial Officer Christopher Liddell declined to do so on a conference call with analysts, investors, and the media. "It is going to be a heavy investment area," Liddell said. "I can't promise you that you'll see a massive turnaround in the short term."

IBM Wows Analysts

Liddell will probably be pressed on the issue again at Microsoft's meeting with financial analysts on July 24, where edgy analysts and investors are likely to reiterate surprise over the spending boost. Even as the company has pumped billions into the business, rival Google (GOOG) has run away with the lion's share of online advertising profits.

Liddell justified the new investments, arguing that analysts project the market to be worth $80 billion by 2012. Di Bona says that's not a good enough argument anymore. "Tell me how Microsoft makes money from these investments," the analyst says. "Show me the money."

Fourth-quarter earnings were eroded as higher-than-expected sales in the company's consulting business and Xbox division lifted expenses. What's more, Microsoft hired more workers than planned, also boosting costs.

The company also shaved a penny a share off its previous guidance for fiscal 2009, saying that earnings per share would come in between $2.12 and $2.18 a share. That's largely tied to the new online spending, and not expenses run amok, Liddell says. "I'm comfortable that there's not any lack of control in spending," Liddell said.

Nonetheless, Wall Street pounded Microsoft in after-hours trading. Shares fell about 6%, to 25.88, after rising 26¢, to 27.52, in regular trading.

In contrast to Microsoft's miss, IBM (IBM) on July 17 announced financial results that led Citigroup (C) analyst Richard Gardner to say during the company's conference call: "It's hard to find anything to question." IBM's revenues rose 13% to $26.8 billion and its per-share earnings rose 28% to $1.98. "These are truly powerful results," IBM Chief Financial Officer Mark Loughridge said on his company's conference call with analysts. "We performed better than ever." He raised the company's EPS estimate for the year by 25¢ to $8.75—which would be a 22% increase.