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Friday, July 28, 2006

Microsoft's Wrong Turn: Could Its Stock Go Below $20


Steve Ballmer, Microsoft's CEO, told analysts that he want to turn Microsoft into a "multi-core" firm with four key businesses. These would be the operating system business, the enterprise Office business, online operations like MSN and Microsoft Live, and an entertainment and device business. He seems to be off to the right start. Company executives said that the think the oft-delayed Vista upgrade to Windows will launch on its new projected date, if it is ready. The company also said it would spend "hundreds of millions of dollars" on its iPod competitor, called Zune.

Key to the company's succcess will be having search technology be a function of all of its software and not a "destination", a clear shot across the deck of rival Google. Microsoft is so far behind in search share of market that catching Google, or even Yahoo!, would appear to be nearly impossible.

At the center of the company's strategy is the delivery of software over the internet which will replace the notion that functions like the operating system, word processing, spreadsheets, and other functions will be loaded on PCs and servers before they are shipped.

Since MSN, Xbox, and the company's move into the delivery of products like VOIP and IPTV has not proved to be a huge success, the gamble on the delivery of the new Vista system and its component parts is critical. Microsoft admits that it loses money on every Xbox shipped. MSN is behind Yahoo!, Google and AOL in audience, and Zune's profits are at least five years away by the company's own calculations.

Microsoft is projecting revenue growth of its Office franchise at as much as 10% for the fiscal year ending June 30, 2007. That assumes that Vista is launched in a timely manner, and that Microsoft's ability to sell more of its software online will work. Vista ships to corporate customers in November.

Aside from the risk that Vista adoption will happen on Microsoft's timetable, the idea of selling software online, via a "subscription" model is still largely unproven. The applications that have been successful in online adoption are largely free like the Google spreadsheet offering and eBay's Skype VOIP software. The huge distributions of some of these applications proves only one thing: if you give away software, you may get a lot of takers.

Microsoft's bet on online delivery of its products to increase penetration and revenue is a significant gamble on a business model that is largely unproven, and its is build around the delivery of the company's most profitable franchises. Microsoft can hope that MSN, Xbox and Zune will become larger operating income contributors, but so far the evidence of that does not point to tremendous success.

With so much at stake, and so much at risk, its is not surprising that Microsoft's stock trades at $23.87, not much above its 52-week low. Even news of a gigantic share buyback has not moved it up much. If Microsoft's changing strategy to build its "four pillar" business falters at all, the stock could drop below $20.

Douglas A. McIntyre can be reached at He does not own securities in companies that he writes about.

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