Who would think that a company with a cash and investments war chest of $25 billion would be under threat from changing consumer consumption patters and a sluggish economy and cannot do anything about it. Microsoft is facing this threat and for the first time in its 35 year history, the company is laying off employees and "attempting" to cut expenses.
There is currently a significant slowdown in desktop and laptop sales as both consumers and enterprises pull back on purchases. Chief information officers are simply recycling old computers, and given the massive layoffs at most companies, there is no need to buy new computers. This is exerting significant downward pressure on the client services and the business division, both of which depend on the sales of PCs and together represent 60% of revenues and more than 75% of operating income. Not good.
Even the upcoming Windows 7 roll-out is unlikely to spur significant upgrade sales, although reviews of the product has been extremely positive. Further, the rapidly growing netbook product is cannibalizing PC sales and contribute less revenues and profits for Microsoft given their low ASPs.
The online services business is facing the combined headwinds of a deteriorating online display advertising market and Google on search.
The entertainment business is growing strongly but operating margins in this business is minuscule.
And finally, the server and tools business, which has 20%+ margins is experiencing a pullback in demand, although growth in the most recent quarter was a healthy 15%. Furthermore, deferred revenues declined a few percentage points sequentially for the first time in several years.
So what is management doing given that these threats are beyond their control and if continued could spell the first secular decline in the company's history. They announced a headcount reduction but that only represented 2-3% of employees and most of it is not immediate and will occur over an 18 month period. In addition, despite the $1.5 billion in annual savings from the expense reductions, most analysts have second half FY09 operating expenses increasing close to $1 billion.
Management suspended stock repurchases possibly signaling that their shares could fall further (or they want to conserve cash for a Yahoo acquisition).
Microsoft is one of the greatest and most successful companies known to man but given the current headwinds it is difficult to invest in this stock with conviction. Estimates on the Street are likely to come down as we progress throughout the quarter as business conditions deteriote more than expected. Thus, I am staying on the sidelines for now until I see a few of these pressures abate. See my prior write-up on the software stocks as a safe haven here.
Wednesday, January 28, 2009
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