Microsoft (MSFT) just released earnings that were mediocre but not any worse than was expected. It said that the balance of the calendar year would not be much better. In stating that, it is taking a position that has been common among most big companies releasing earnings. Write off 2009. Wait until next year.
Revenue for the company's fiscal third quarter, which ended on March 31, fell 6% to $13.65 billion. Operating income was $4.4 billion, so Microsoft's software businesses still produces tremendous margins. The company blamed the weakness in the global PC and server markets for most of its troubles. The only really good news Microsoft had is that the latest versions of its flagship product, called Windows 7, will launch on time next year. (See 25 people to blame for the financial crisis.)
As would be expected, Microsoft's largest business, its PC software operation, suffered a 15% decline in revenue to $3.4 billion. The division still made an operating profit of $2.5 billion. There are very few large businesses in the world with a margin that large. The company's server and tools division and business software operation had similarly impressive operating numbers.
Most of the headlines about Microsoft are about how much it needs a deal with Yahoo! (YHOO) to bolster its online business. That may be true, but overall it is a tiny part of the world's largest software company. In the last quarter, Microsoft's online operation had modest revenue of $721 million, a drop of 15% compared to the same quarter a year ago. Yahoo! suffered a similar decline in its first quarter, so putting the two businesses together might not be as exciting a business prospect as most analysts believe.
For most of the years since the company was started in the late 1970s, Microsoft has grown rapidly. That is not going to happen anymore. It is too large and that makes it a captive of the economy. Microsoft is not going to outperform the trends in global technology spending by a great deal, and it will rarely do much worse. What will happen is that Microsoft will remain the dominant force in business, server, and PC software for years. The company's products are too ubiquitous and too well-designed to be easily replaced. Microsoft will have competition, but that competition will not transform the software industry overnight because Microsoft's products are the glue that holds together a very large portion of the technology used by businesses and consumers around the world. (Read a 24/7 Wall St. story on Microsoft.)
Microsoft has reached the point where it is very much like Wal-Mart (WMT) and McDonald's (MCD). Neither of those companies is growing rapidly, but both dominate their industries, throw off huge amounts of cash each year, and have balance sheets that are the envy of most other large multinational companies.
For the people who run Microsoft, especially Steve Ballmer who has been at the firm for 30 years, there is a certain amount of humiliation that goes along with no longer being the world's fastest growing global enterprise. But, Microsoft's fate was unavoidable once it started to have a 90% market share in a number of its core businesses. There are, essentially, no more worlds to conquer.
Investors are still concerned that Google (GOOG) can do a great deal of damage to some of Microsoft's most important enterprises. The search company has created products which could compete with Microsoft's big money makers, but, so far Google has had very little success in getting adoption for its software tools. The world may use Google for search, free maps, and free news, but it ends there.
Microsoft may forge a partnership with Yahoo! and there may be some benefit in the No.2 and No.3 companies in the search engine business teaming up to take on Google. But, Yahoo! is a fairly weak operation, which means it is not an ideal partner.
But, what happens if Microsoft cannot mount a successful challenge to Google's main business? Probably nothing. From a financial standpoint, the software business is better than the search business. The revenue is better, and so are the margins. Microsoft will remain successful, more successful than Google, because it owns the more valuable real estate. Being a growth company is overrated.
Douglas A. McIntyre
For constant business updates, go to 24/7wallst.com.