Last week, tech bellwether Microsoft (MSFT: Charts, News) surprised Wall Street when it posted third quarter revenue and earnings that topped all expectations. Microsoft earned 60 cents per share on revenue of $17.4 billion, beating the average analyst forecast of 58 cents per share on $17.16 billion in revenue. The company also offered an encouraging reduction of its expense outlook for the full year, decreasing it to a range between $28.3 billion to $28.7 billion. The company originally forecast an expense outlook between $28.5 billion to $28.9 billion back in January.
Over the past decade, Microsoft has lost market share in key business segments to rivals Apple (AAPL: Charts, News) and Google (GOOG: Charts, News), failing to capture a significant slice of the booming smartphone, tablet and cloud computing markets. However, strong sales in its Windows and Windows Live department, as well as the upcoming release of Windows 8, has forced analysts to rethink their bearish or indifferent positions.
Microsoft’s Windows and Windows Live segment posted a 4% increase in revenue from the prior year quarter. The company’s Server and Tools segment also posted a 14% gain in revenue, reflecting the strong demand for strong enterprise server solutions that has helped keep VMWare (VMW: Charts, News), Hewlett Packard (HPQ: Charts, News) and IBM (IBM: Charts, News) afloat in unpredictable times. Bill Koefoed, Microsoft’s head of investor relations, also noted that the segment’s 20% growth in bookings was comparable to the growth of smaller competitor VMWare, which also posted earnings last week. Microsoft’s SQL server product also garnered strong growth with both its regular and premium versions. The company’s products remain popular to customers using its analytic tools, which are in high demand in enterprise software.
Microsoft’s Business division posted a 9% gain in revenue, while its Online Services Division grew by 6%. Although its Online Services Division posted an operating loss of $479 million, it was still a marked improvement over the $776 million it lost in the previous year.
Microsoft’s Entertainment and Devices segment, which produces its Xbox hardware and software, fared the worst, posting a 16% decline in revenue, attributed to a soft gaming console market. This is unlikely to change in the near future, since the gaming industry recently reported a 25% year-on-year decline in March. Microsoft stated that Xbox Live had strong content during the quarter, but its hardware may also be reaching mature saturation. Its Xbox 360 system is currently the most popular video game console in the United States, accounting for 42% of all console hardware shipments during the last quarter. Koefoed remained optimistic about the segment’s growth during the second half of the year, when several high profile titles, including the Xbox exclusive “Halo 4″, are set for release.
CEO Steve Ballmer remained optimistic regarding the company’s full year growth potential. Ge stated, “With the upcoming release of new Windows 8 PCs and tablets, the next version of Office, and a wide array of products and services for the enterprise and consumers, we will be delivering exceptional value to all our customers in the year ahead.”
Several analysts upgraded Microsoft on the company’s strong earnings. Nomura analyst Rick Sherlund commented, “We are now two quarters away from the launch of several strategic and high-margin products, starting with Windows 8 in September or October.” Sherlund currently has a price target of $37 on the stock. Meanwhile, Davenport & Co. analyst Drake Johnstone upgraded the stock from neutral to buy with a price target of $40.
Besides Windows 8, investors should also pay attention to the release of Office 15, which could be threatened by free alternatives, such as Google Docs or Oracle’s (ORCL: Charts, News) Open Office software suite. Microsoft’s current deal with Nokia NOK, in which Microsoft uses Nokia as its primary hardware platform for circulating Windows Mobile, will also dictate the company’s ability to compete with Apple and Google in the smartphone and tablet arenas.
Microsoft shares currently trade at 10.6 times forward earnings with a 5-year PEG ratio of 1.5. The stock also has a low beta of 1 and pays a quarterly dividend of 20 cents per share, making it a strong defensive candidate against economic turbulence during the summer.
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