Can Windows 7 'Reset' Microsoft Shares Higher?

(page 2 of 2)

For the moment, analysts seem to think Microsoft can pull it off. After several quarters of decline, Microsoft is poised to start growing again. Before the first-quarter report, analysts expected Microsoft to generate $17.12 billion in sales for the second quarter—an increase of 14%—and earn 52¢ a share. The surprisingly strong first quarter will likely prompt Wall Street analysts to raise estimates even higher.

Business Users Ignored Vista, Kept XP

One potential roadblock for Microsoft is Apple, which has been grabbing market share in the U.S., and now accounts for 8.6% of PC sales there, according to market researcher IDC. Apple's computer shipments grew by 12% in the third quarter while the overall PC market grew at an anemic 2.5%. Worldwide PC sales increased 2.3%, IDC said.

What's more, Microsoft will need to overcome weakness in sales to businesses, which largely bypassed the Windows Vista operating system released in 2007, perceiving it as slow and lacking in compelling features. Instead, companies stood pat with older machines. Consumers, meanwhile, have been gravitating to low-priced netbooks that run a discounted version of an earlier operating system, Windows XP.

Windows 7 will likely help Microsoft on both fronts. The software has received positive reviews. Windows 7 helps PC users more easily manage files and it starts and shuts computers faster. It eliminates many of the annoyances that bothered Vista users. Windows 7 also gives Microsoft a better-performing—and higher-priced—operating system to sell on netbooks. "The end result may be that Microsoft sells more versions of Windows 7 at lower price points, but if Microsoft did not meet this emerging demand," rivals would, said Allan Krans, an analyst at consultant Technology Business Research, in an Oct. 23 report.

Microsoft has more than Windows 7 to rely on. Cost-cutting could boost shares by increasing operating margins. Microsoft's profit margins have been declining over the past seven years as the company entered expensive new businesses such as Internet search and video games. The operating margin in fiscal 2009 was 34.8%, down from 46.3% in fiscal 2001. "One of the biggest hangups investors have had about Microsoft the past few years is their spending on the online side of the business," says Jeff Gaggin, a vice-president at Avian Securities who rates Microsoft a buy.

An 8¢ Surprise, Aided by Xbox

To rein in expenses, Microsoft is cutting its staff and reducing marketing and other costs. Operating expenses fell 7% during the quarter ended Sept. 30.

Sales declined to $12.92 billion, and profit fell to $3.57 billion, or 40¢ a share, Microsoft said. Wall Street analysts expected Microsoft to earn 32¢ per share on revenue of $12.32 billion. A year ago, Microsoft earned $4.37 billion, or 48¢ per share, on sales of $15.06 billion. Surprisingly strong sales of Microsoft's Xbox video game console and royalties from games sold for the machine helped boost the results.

First-quarter sales were lower than they would have been had Microsoft not offered coupons for a free upgrade to Windows 7 to consumers who bought Vista in the months leading up to the Oct. 22 launch of the new software. The program resulted in $1.47 billion of revenues, which Microsoft deferred. It will recognize most of those sales in the current quarter.

Liddell didn't give investors guidance for Microsoft's second quarter ending in December, but said businesses were ready to buy new PCs loaded with copies of Windows and Office. Microsoft will continue to hold the line on expenses for at least the next year, he added. "The fiscal discipline that you have seen will continue," he said.

Ricadela is a writer for Bloomberg BusinessWeek in San Francisco.

Business Exchange

Track and share business topics across the Web.