This 1 Particular Part of Microsoft's Resurgence May Surprise You

Microsoft's strong growth over the past year is getting a valuable boost from hardware, which never used to be the case.

Jun 9, 2014 at 10:05AM

For years, Microsoft (NASDAQ:MSFT) critics contended that the company would be suddenly and severely caught off guard by the death of the personal computer. Those bearish on Microsoft frequently surmised that its flagship Office software and Windows operating system, while highly profitable throughout, would go the way of the buggy whip due to the sinking ship known as the PC. This would only be compounded by the fact that its devices, including the Xbox, were a consistent money-loser.

Of course, none of those things happened. Fast forward, and Microsoft has effectively silenced those critics. Newly appointed Chief Executive Officer Satya Nadella took the helm at just the right time. Microsoft has significantly switched focus to the cloud, and Nadella's 22 years as Executive Vice President of the cloud and enterprise group made him an ideal candidate for the job.

Microsoft has engineered a successful strategic shift, and the results speak for themselves. Revenue is soaring in Microsoft's cloud and server businesses, including its highly successful Office 365 product.

What you might not know, however, is that the company's hardware performance is getting lost in the shuffle. You may be surprised to learn that Microsoft's devices and consumer group isn't just surviving, it's actually making a meaningful contribution to the company's resurgence.



Don't look now, but Microsoft is profitable in hardware
For a long time, Microsoft's devices business, led by the Xbox franchise, was regarded simply as a means to connect with consumers. Microsoft banked on getting its brand and other subscriptions and services to you through its Xbox, and was content to absorb losses on the hardware side.

This was common throughout the gaming industry. For example, when Sony (NYSE:SNE) released its PlayStation 3, the precursor to the recently debuted PlayStation 4, it operated under the same model. Despite sales in Sony's games segment soaring 26% in 2007, the company still booked a loss of 124.5 billion yen (approximately $1 billion, based on average exchange rates that year) in that unit.

The same thing held true last fiscal year as well. Sony recently concluded its fiscal 2014, in which it posted a $78 million loss in its games unit, despite sales in that segment soaring 38.5% year over year thanks to the PlayStation 4.

Indeed, when Microsoft released the previous iteration of its gaming console, the Xbox 360, it wasn't a profitable venture. Microsoft reported operating losses totaling more than $3.2 billion in its entertainment and devices division in 2006 and 2007 combined, even though the release of the Xbox 360 was very successful in terms of sales.

Now, that's all changed for Microsoft. Whereas Sony still hasn't figured out a way to turn a profit from its gaming hardware, Microsoft is doing just that. Microsoft managed to turn a $258 million profit on its devices hardware, despite incurring sharply higher costs associated with the release of the Xbox One. Of course, it goes without saying that the lion's share of the company's profits are still associated with its high-margin commercial licensing lineup, which includes its highly profitable server products.

Hardware no longer an anchor
Even though Microsoft has incurred significantly higher costs in its hardware business associated with the release of the Xbox One, it still turned a profit on hardware last quarter. It might not seem like much, but it represents an important turnaround from what had been the traditional gaming hardware business model for years.

Microsoft's closest competitor in the gaming hardware space, Sony, hasn't found the magic formula to generate a profit on hardware. This gives Microsoft a leg up in the gaming space and provides even more of a boost to Microsoft's overall financial performance.

There's no doubt that Microsoft's other segments are performing well, and positive contributions from gaming hardware will only serve as icing on the cake.

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Bob Ciura has no position in any stocks mentioned. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not 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.

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