Stunning Miss By Microsoft Calls Into Question Its Business Model

Shares of Microsoft (MSFT) fell to a new 52 week low after an unexpected earnings miss. Let's take a look at the headline news followed by a discussion.

Reuters is reporting Microsoft stuns with profit miss, to cut up to 5,000 jobs

Microsoft Corp stunned Wall Street with disappointing results that included plans to slash up to 5,000 jobs and a warning that profit and revenue will almost certainly drop over the next two quarters.

Microsoft's shares dropped 9 percent, adding to a 40 percent decline in the past year. It blamed the miss on the weakness of the PC market and the popularity of low-cost netbook computers, which have combined to badly undercut sales of its dominant Windows operating system.

The market has become so volatile, Microsoft cautioned, that it has decided against issuing earnings or revenue forecasts for the rest of its fiscal year ending June 30, 2009 -- other than to predict both will very likely be lower.

"The fact that they are withdrawing guidance is really bad. It adds to uncertainty. It is pretty bad when things are deteriorating so fast that even the largest companies in the world don't know how rapidly it is happening," said Jefferies analyst Katherine Egbert.

Microsoft posted a profit of $4.17 billion, or 47 cents per share, in its fiscal second quarter ended December 31, versus a profit of $4.71 billion, or 50 cents, a year earlier. Analysts were looking for earnings per share of 49 cents, according to Reuters Estimates.

Microsoft said it will eliminate up to 5,000 jobs in research and development, marketing, sales, finance, legal, human resources and information technology over the next 18 months, including 1,400 jobs on Thursday. That amounts to about 5 percent of its estimated 96,000 work force, the biggest ever cuts by the software maker.

As bad as this result was, imagine the carnage had Microsoft bought Yahoo for its offer of $44.6 billion ($31 per share) back in February. Microsoft got lucky when Yahoo rejected the offer, demanding $40 per share. See Yahoo to Reject Microsoft Bid for details.

Yahoo is currently trading at $11.44 and Microsoft would have been without a monstrous pile of badly needed cash.

Microsoft, An Aging Gorilla

Microsoft is an aging Gorilla facing many battles. The first is declining PC sales as discussed above. A second more serious problem is that it's products are too expensive and too buggy. A third problem of Microsoft is a shift to web-based services.

Free versions of word processors and spreadsheets by OpenOffice (OO) have cut off growth of Microsoft's flagship Word and to a lesser degree Excel. Corporations use Microsoft products predominantly because they are used to using them. There is no fundamental reason to do when it comes to word processors.

As for Excel, Micosoft has an advantage in graphics, but most can easily do without. Over time, OO spreadsheets will improve, negating, perhaps even reversing that advantage. As for right now, why should corporations pay for Excel for everyone, when perhaps only a small percentage of users need the extra features of Excel? A better business decision for corporations would be to provide OO for everyone, and on a case by case basis provide Excel to those who really need it.

Finally, there is a fundamental shift in the industry to web-based services by Google and other providers. These products are also free. This too is eating into the demand for Microsoft products.

The day of reckoning is at hand for Microsoft. Many US corporations currently married to Microsoft software will start looking long and hard at its products, from multiple angles. That Microsoft could not provide forward guidance is proof enough that its products are simply too expensive for this deflationary environment where every penny counts.

OO is the epitome of deflation. You can't beat free.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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