2 Things That Should Scare You About Microsoft's Earnings Report

Go ahead and mark the time. Wintel is dead. In an otherwise good second-quarter report from Microsoft (Nasdaq: MSFT  ) -- Mr. Softy beat Street estimates by $0.03 a share -- revenue in the Windows division fell 6%. Intel's (Nasdaq: INTC  ) PC division saw a 17% sales increase over the same period, demonstrating some key differences in the Wintel relationship.

Both companies work with Apple (Nasdaq: AAPL  ) , the only computer maker to record gains in 2011's fourth quarter, but only Intel is guaranteed revenue with every Mac sold. And that leaves Microsoft alone to figure out its place in an increasingly post-PC world.

Betting on the "enterprise" in a consumer-driven economy
You'd think Microsoft was set in a Star Trek movie for as much as executives talk about the "enterprise," an amorphous term that essentially refers to larger businesses that are willing to spend millions at a time outfitting data centers and personal computers with battle-tested software.

To a large degree, they're right. Microsoft's Business Division, which supports the Office suite of productivity software, produced $6.28 billion in revenue for fiscal Q2, a 3% increase over last year's second quarter.

And while the Windows division saw a revenue decline, it still accounted for $4.74 billion in sales. Yet it's the trend that matters in investing, and the Wintel divergence proves Microsoft's once-legendary stranglehold on the computing market has loosened.

What caused the shift? Changing habits, I think. For consumers, PCs have outgrown their traditional home on the desktop. Now we carry them in our pockets, purses, and portfolios. We also don't call them computers anymore. Instead, we refer to them as smartphones and tablets.

Two years ago, data traffic on mobile networks outstripped voice traffic for the first time. Roughly 400 million smartphone users accounted for that data deluge. Apple has sold at least 100 million more iPhones and iPads in the two years since.

Bill Gates must be cringing. He was talking up tablets and mobile computing years before Apple said anything about an iPhone or iPad. Yet over the past two years, Mr. Softy has been largely MIA from the market it helped to pioneer. Irony, thy name is Microsoft.

All of which leads me to the first reason you shouldn't cheer this earnings report. While Windows revenue was down 6%, operating profit for the group fell a more troubling 11% while the other twin tower, the Business Division, saw a 3% revenue gain cut in half on the profit line by lower margins.

Will Ballmer rally developers once more?
Lack of developer enthusiasm is the reason you should worry. Microsoft seems to know it, too.

"I would say one of the things [we] talked about at CES last week was just how important it is for us to work on and with developers to create a really vibrant developer ecosystem," said Bill Koefoed, Microsoft's general manager of investor relations, during the call with analysts.

He's right. Developers have more options than ever, and there's increasing evidence that they're writing for newer platforms such as Apple's iOS. And those who aren't writing for Apple are spending time creating Web-based apps. Last quarter, salesforce.com (NYSE: CRM  ) chief executive Marc Benioff told analysts that some 450,000 developers had built apps for the company's Force.com Internet-based platform for creating and deploying software.

A now-legendary video from several years ago shows Microsoft CEO Steve Ballmer sweatily rallying a crowd of coders at a company conference. "Developers! Developers! Developers! Developers!" went Ballmer's chant, accompanied by an audience clapping in tune. To listen to Koefoed's comments is to wonder whether another rally is in order.

There's certainly a need. While moves to unify all editions of Windows in version 8 -- due to reach beta next month -- should entice developers to spend more time with the OS, the changes are also long overdue, and they're coming as just coders are committing more time to other systems.

Making the call: Don't buy
For me, these twin forces add up to a compelling reason to avoid buying Microsoft right now. Yes, I realize a big dividend payout could substantially lift the stock. Yes, I realize the PC market is far from dead. Nevertheless, cracks are showing in Mr. Softy's foundational businesses. I see little chance that this stock will outperform the market while these problems remain unaddressed, and I've made a CAPScall to underscore my conviction.

Do you agree? Disagree? Either way, if you're a tech investor, it makes sense to be studying the implications of the post-PC world emerging around us. The Motley Fool recently identified a handful of potential winners in a report titled "3 Hidden Winners of the iPhone, iPad, and Android Revolution." Thousands have already requested the report, which is available for a limited time. Get your copy before this offer expires -- the research is 100% free.

Fool contributor Tim Beyers is a member of the Motley Fool Rule Breakers stock-picking team. He owned shares of Apple and salesforce.com at the time of publication. Check out Tim's Web home, portfolio holdings, and Foolish writings, or connect with him on Google+ or Twitter, where he goes by @milehighfool. You can also get his insights delivered directly to your RSS reader.

The Motley Fool owns shares of Apple, Microsoft, and Intel. Motley Fool newsletter services have recommended buying shares of Microsoft, Intel, Apple, and salesforce.com, creating a bull call spread position in Microsoft, and shorting salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 22, 2012, at 3:08 PM, Edeskimo wrote:

    I half-heartedly agree with you that MSFT may be decreasing in importance in the computing world with the shift to tablets. It'll be very important to see how their venture with Nokia works out because it would be great if that combo produces products that can compete with Apple in this space.

    Right now I've decided to sell calls on my existing MSFT shares but would buy again on a dip to $24 because I feel the stock goes through lots of cycles of pessimism and optimism. I think there is too much optimism in the stock until they prove they can compete in the mobile space.

    I am cheering for them as I don't like Apple's predatory nature. I also like using Office OS and Windows 7 and I hope their can be very good linkages with them on a smartphone that will run seamlessly with these PC-based software applications.

  • Report this Comment On January 22, 2012, at 3:14 PM, MrMystery44 wrote:

    I disagree. If Microsoft had a high valuation or was priced for any growth, I would hold or sell. It does not, so I say buy. It is no surprise to me that revenue in the windows division would drop when a new version is near (as you say, beta next month).

  • Report this Comment On January 22, 2012, at 3:34 PM, ConstableOdo wrote:

    It appears to me that Microsoft went up on earnings at a higher percent than Apple is likely to do if it goes up at all. It does appear that investors were doing more buying of Microsoft than selling off as they will with Apple. Both Microsoft and IBM did well on earnings whereas Apple will likely do very poorly, as usual. Warren Buffett owns both Microsoft and IBM while he'll probably stay well clear of Apple. He's decidedly anti-Apple. Look for Apple to blow earnings again for shareholders. Three quarters in a row is really setting a lousy trend for Apple and shareholders. Analysts say Microsoft is going up to around $35 and doesn't have that far to go.

  • Report this Comment On January 22, 2012, at 3:46 PM, Klippenstein wrote:

    So if Microsoft is in decline who will lead the charge over next few years? Apple? Google? You undermine Microsoft's Windows 8 effort to what? ... cheer Apple's strategy of "forcing" every Mac user to buy both an iPad and a Mac ... for $1,500 or more. I was at CES last week and I think you missed an important point. The PC is not dead, it has just added a new easier to use interface, the touch screen interface of the iPad. This is what Microsoft is doing with Windows 8 and, if they do it right -- and there are encouraging signs -- the Microsoft Windows division will again be talked about as a growing business. Apple, has not even attempted what Microsoft is close to completing -- integrating the iPad with the Macintosh notebooks. But by redefining the Tablet as again a simple part of a $700 PC (now running on the ultra thin ultrabook forum factor), Microsoft will move its technology back into the center of the consumer computing space. Windows 8 is Microsoft's chance of selling us Windows all over again, likely in a new ultrabook with a touchscreen. I won't sell my Microsoft shares yet.

  • Report this Comment On January 22, 2012, at 3:49 PM, Klippenstein wrote:

    Another thing to contempt is that IBM, which died decades ago, is alive and well focused solely on the enterprise. Microsoft is again working to do the more challenging thing, be in both consumer and enterprise spaces. Both are important and can be very profitable.

  • Report this Comment On January 22, 2012, at 5:09 PM, RLLH wrote:

    I do hope people believe your article. As one accumulating Microsoft stock in my dividend portfolio, I always prefer a lower stock price. Keep up the good work.

  • Report this Comment On January 22, 2012, at 8:03 PM, techy46 wrote:

    "Bill Gates must be cringing. He was talking up tablets and mobile computing years before Apple said anything about an iPhone or iPad."

    Yes, Bill's really cringing with $35 billion in his portfolio with $18 billion in MSFT. Computing isn't shifting to tablets, computing runs on mainframes and servers and consumer of content are shifting to tablets and so is Microsoft with Windows 8. If MSFT can beat with a consumer shift and slower PC sales just think what happens when the monkeys discover that Mangos are tastier than Apples.

  • Report this Comment On January 22, 2012, at 8:05 PM, techy46 wrote:

    Oh, and Bill made $960,000,000 on his MSFT stock on Friday.

  • Report this Comment On January 22, 2012, at 8:25 PM, mrpither wrote:

    Hmmm... and yet if you add up all IOS devices (includes precious iPads) and macs and android devices, that number is still FAR far less than the numbers of just Windows 7 copies in the wild. No comfort their?

  • Report this Comment On January 23, 2012, at 10:53 AM, Klippenstein wrote:

    Ok guys, there is too much of a consensus here that Microsoft and PCs are not dead. I think we're right, but this next year should show whether we have it right.

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