Is Microsoft Really Clueless?

From A (Apple (Nasdaq: AAPL) as a competitor) to Z (Zune), Microsoft (NYSE: MSFT) is having a tough time of it these days. Many of its products are busts, and management has been called clueless. All this negativity is no doubt depressing the stock price as well.

What the heck is going on in Redmond? Are things really as bad as they seem? Can Mr. Softy get his hard edge back and reward shareholders like me?

Having a blunderful time
Microsoft's most notable blunders have come mostly in the consumer products category. You know, those things we consumers really tend to notice. Like how the original Zune MP3 player -- that brown, featureless block -- failed to capture the imagination of anyone outside the brick-laying industry. Microsoft had to compete with the form, function, and aesthetics of Apple's iPod, and came up short. Zune is still around (and a bit sleeker), but it's hardly made a dent in the consumer consciousness.

Or the Kin phones: "OMG, LOL!" as the kids say today. Not even two months after launch, Microsoft threw Kin on the barbie, and killed the phones. While Apple sold 1.7 million iPhone 4s in three days, there are reports of fewer than 10,000 Kins in circulation.

This is a bad omen as the company is preparing to launch the Windows Phone 7 mobile OS in the coming months. Phones based on this software will start at a serious disadvantage to iPhones, Research In Motion's (Nasdaq: RIMM) BlackBerrys, and Google (Nasdaq: GOOG) Android-based devices. When carriers such as AT&T (NYSE: T) and Verizon (NYSE: VZ) decide where to place their marketing muscle, do you think they'll go with the proven winners, or a proven loser in the mobile space? One Microsoft executive told the New York Times that Verizon employees were reluctant to sell the Kin, promoting Android phones instead. It's going to take a lot to overcome this kind of thinking.

There are other disappointments, of course. From tablet computers to Windows Vista, Mr. Softy has been tagged as mediocre. Lukewarm. Boring. Aside from the Xbox gaming platform, it's tough to come up with anything that's generating positive buzz.

First, the good news
The bright side of all this is these consumer products mean nothing to Microsoft's bottom line. If you look at the table below, you'll see that over three-fourths of the company's revenue and nearly all of its profits come from the non-consumer business side -- Windows Server software, Microsoft Office products, etc. -- and its stranglehold on PC operating systems with the likes of Windows 7, XP, and Vista. Here's a breakdown by segment:

*Operating profit before tax.
Not all segments are listed. Totals will not sum to 100%. Data provided by Capital IQ.

For a company that raked in over $20 billion in free cash flow over the past year, these product failures can hardly be viewed as catastrophic. Thousands of companies wish they had Microsoft's problems (along with the $37 billion it has in the bank)!

So investors should look at these consumer-facing products as management does -- relatively small bets, placed in the hope they turn out to be big winners.

And now, the bad
While we investors should applaud these bets, we should also be worrying that none of them is really paying off. It's gone beyond what we could rationally view as a random streak of bad luck. The Kin debacle points out that management really is clueless about many things. This seems to be a company that's out of touch and hurting for creative minds.

What's more, Google in particular is pressuring Mr. Softy even in its strongest areas. "That Google has made Microsoft its whipping boy in online search is hardly news," notes our own Motley Fool Inside Value. "More troubling, though, are Microsoft's rival's attacks and rapid ascents in key competitive arenas." These include the Google Chrome Web browser, Google Docs and Apps, and the upcoming Google Chrome operating system. All these products are free and have to affect Microsoft's pricing power.

Buy, hold, or sell?
Because of its dominance in operating systems and the business space, this is a rather low-risk stock with limited downside. Cash-producing machines like this are few and far between. If you think management can get its act together and regain some of the old Microsoft magic, the current price -- around $24 and10.5 times forward earnings -- is a fine entry point.

However, I have my doubts about the magic returning to Redmond any time soon. I'm fine holding my shares for the time being, but once a better opportunity comes along (and they usually do, on a regular basis) they'll be among the first I sell.