Microsoft Seeks To Assuage Street’s Software, Web Concerns

Jul.23, 2008 in Market Outlook

Last Update: 7/23/2008 3:13:23 PM

By Jessica Hodgson
Of DOW JONES NEWSWIRES

SAN FRANCISCO (Dow Jones)–The challenge for Microsoft Corp.’s (MSFT) future will
be to let go of its past.

For years, the Redmond, Wash., software giant’s Windows operating system and
Office suite of applications have dominated the computer software market. Some
90% of the world’s personal computers run on a version of Windows. Computer
makers bundle Windows, as well as Office applications, with new machines, driving
revenue.

Now competitors are chipping away at Microsoft’s primacy. Apple Inc.’s (AAPL)
operating system is catching on with corporate buyers, while the freely
distributed Linux system is starting to appeal to tech-savvy consumers.

Meanwhile, “cloud computing,” a broad term for applications distributed and
hosted online, has tempted competitors like International Business Machines Corp.
(IBM), Google Inc. (GOOG) and Salesforce.com (CRM) to enter the business software
market.

As computing’s center of gravity moves online, Microsoft faces one of the most
significant challenges in its 33-year history. It must become a credible
competitor online without damaging its multibillion-dollar software franchise.
And it must do this without the guiding hand of its founder, Bill Gates, who
retired last month. On Thursday, Wall Street hopes Microsoft will give an idea of
how it will accomplish that task when it holds its annual meeting with analysts.

So far, Microsoft’s efforts to engineer this transition have produced few
concrete results. Its attempt to buy portal Yahoo Inc. (YHOO), an acquisition
that would make it the second-biggest online search provider, have stalled.
Losses at its Online Services Business widened during 2008.

Meanwhile, sales at the Business division, which handles the Windows and Office
franchises, have missed revenue guidance for two consecutive quarters. The
company has acknowledged that Office, a cash cow that raked in almost $19 billion
last year, will likely slow to single-digit growth in the future.

“The company’s core growth potential will ultimately be determined by success or
failure of its various online initiatives,” wrote Charles di Bona, an analyst at
Bernstein Research, in a recent note.

Neither di Bona nor other analysts suggest Microsoft needs to make changes
hastily. The company has a powerful arsenal of resources - including software
engineers and sales channels that are the envy of the industry - at its disposal.
With its core franchises solidly profitable and $10 billion in the bank,
Microsoft has both cash and time to design a solution.

Still, concerns over those challenges are increasingly reflected in Microsoft’s
stock price, which has dropped by around 25% so far this year. On Thursday, the
company’s shares were recently up 1.6% at $26.18, close to the 52-week low of
$23.19.

Microsoft has recently ramped up plans to make more of its products available
online. These include an advertising-funded version of Office and a suite of
products like Microsoft Exchange Server and Sharepoint collaborative software,
which a spokeswoman said had already persuaded 5.1 million users, including Nokia
Corp. (NOK) and Coca-Cola Enterprises Inc. (CCE), to switch from a competitor’s
software. This initiative underscores the company’s commitment to making more of
its core productivity tools available online, a spokeswoman said.

Helping Online

Analysts say Microsoft’s most pressing challenge is to deliver results from its
Online Services Business, which includes Microsoft’s Live search engine and
aQuantive, an online advertising business. Losses at the unit widened to $488
million for the fourth quarter, compared with $210 million in the same period a
year earlier.

Other than buying a major company, however, there is no easy fix because it is
difficult to grow these businesses organically, analysts say. Though investors
initially worried Microsoft might overpay for Yahoo, concerns have now shifted to
what the company’s position might be without a deal.

“Investors are going to be trying to corner (Microsoft) on its Internet strategy
and will want to come away with some comfort on the issue,” said Walter
Pritchard, an analyst with Cowen & Company.

The company must also address the future of its core Windows and Office products.
Microsoft’s Vista operating system, the latest version of Windows, has had a
lukewarm reception since its release two years ago. Many big companies, including
General Motors Corp. (GM), have hesitated to upgrade. Meanwhile, hardware
partners like Hewlett-Packard Co. (HPQ) and Dell Inc. (DELL) said they would
continue to ship computers with the previous system, XP, even though Microsoft
has stopped supporting it.

Less than 10% of chief information officers polled by Bernstein Research are
using the new software.

But Microsoft’s most fundamental challenge will be positioning itself for a world
that is moving toward online applications, a model in opposition to the way it
currently makes money. Microsoft sells licenses to its programs, which then run
on a user’s computer. When new versions are released, many users automatically
upgrade, driving new revenue.

That model is being challenged by cheap or free alternatives, like OpenOffice,
which are available online and provide many of the same functions, says Andy
Miedler, a software analyst at Edward Jones. Other services, like Google Apps,
allow people to work on a document or spreadsheet and store it on outside
servers, giving them access to their work from any computer connected to the
Internet. Microsoft sells some services online, but they are not a significant
driver of sales.

“Microsoft is under pressure to position its core products for use in the cloud,”
says David Smith, an analyst with Gartner. The company’s limited online offerings
“is perceived to be rather a defensive strategy,” he says.

Microsoft is aware of the challenges and is trying to address them. Ray Ozzie,
Microsoft’s chief software architect, has spearheaded the creation of Live Mesh,
which lets users to synchronize data on different machines. Many people see Live
Mesh as a building block for Microsoft to transition its products online.

Still competitors sense an opportunity is being created.

“With the latest version it seems that the upgrade cycle may have been a bridge
too far for customers,” James Whitehurst, chief executive of Linux software maker
Red Hat Inc. (RHT), said about Vista.

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