3 Huge Risks Microsoft Corporation Investors Should Consider

The Satya Nadella era has been characterized by optimism. Will Microsoft be able to navigate the risks it faces and continue its growth?

Jul 7, 2014 at 12:00PM

Source: Microsoft.com

Microsoft (NASDAQ:MSFT) has been on an impressive run. The pessimism that characterized the end of the Steve Ballmer era appears to have given way to optimism surrounding new CEO Satya Nadella's chosen direction. The company's most recent quarterly report beat expectations, and its valuation grew substantially from there.

At the start of a new fiscal period, the company's share price trades approximately 23% higher than it did at the beginning of last July -- good enough to put it in the neighborhood of 14-year highs. Microsoft is making major strides with its cloud-computing initiative, with the company's Azure platform now second only to Amazon Web Services in terms of public cloud usage. While the company's fast turnaround has been undeniably impressive, there are still reasons to be cautious about the future. Is Microsoft a solid investment amid substantial threats from competitors like Google (NASDAQ:GOOGL) (NASDAQ:GOOG)?

Windows is shaky
Windows 8 has had a troubled product life cycle. The new operating system had its public release nearly two years ago and experienced slower-than-expected adoption, partly because of the declining PC market. Some have speculated that negative reviews and bad word of mouth for Windows 8 actually damaged the traditional personal computer segment, dousing the proverbial fire with gasoline. Hardware manufacturers like Toshiba have indicated that its enterprise clients will stick with Windows 7-based systems and that they have shown little desire to switch to the newer system, even as support for Windows XP ended in April.

The ho-hum response to Windows 8 has shifted attention to Microsoft's next operating system faster than usual. With approximately 25% of the company's 2013 revenue coming from Windows, and the lion's share of Windows spending coming from businesses, Microsoft opens itself up to substantial risk when it releases substandard operating systems. The company's reputation for releasing duds (see also: Windows ME) in between more esteemed efforts becomes increasingly problematic with the traditional computing market in flux. Windows 9, or "Threshold" as it's being called, will need to deliver much more than return of the coveted "Start" menu.

The Office empire could decline
In fiscal year 2013, approximately 32% of Microsoft's revenue was generated by its Office-driven Business division. As the PC market continues to decline, and sustaining the Windows user base faces mounting hurdles, the company's incredibly lucrative Office business is at risk. This reality is part of the reason why the company has made moves to bring itself more in line with a devices and services model, though the value of that strategy is the subject of internal dispute.

Microsoft is also seeing the rise of significant competitors in this space. Google has taken aim at the Office empire with its web-based Docs suite and Chrome OS. With the growth of the Internet giant's Android platform, the future could see Google taking a significant bite out of Mr. Softy's most lucrative enterprise. There are also other Office competitors to keep an eye on such as Apache Open Office, an open-source alternative to the popular work suite. Even with its increased cloud functionality, the value proposition of Microsoft's Office is under attack.

Microsoft's hardware initiatives could continue to fall flat
The $7.2 billion acquisition of Nokia has been the subject of much discussion. With the move completed, Microsoft has taken on a sizable business that doesn't generate profit in hopes that a better foothold in the mobile industry will position the company for the future. Windows Phone and Surface can, thus far, be described as disappointments, but the company will continue to chase a hardware presence in the smartphone and tablet markets because it's an avenue for preserving its software business.

Part of the problem with Microsoft's hardware initiatives is that the company doesn't appear to be fully behind them. Microsoft receives a cut of Android sales, good for approximately $2 billion per year, and will feature Google's operating system on Nokia phones it produces. While this setup is currently good for the bottom line, the company is effectively hedging its bets to the point where it's competing with itself.

A related conflict of vision within the company can be seen with its Xbox One console. The gaming system has posted solid numbers, but it's lagging sales of Sony's PlayStation 4 by a substantial margin, and visible figures like Microsoft co-founder Paul Allen and current VP of devices Stephen Elop have indicated a desire to spin off the business. Competing in the smartphone, tablet, and gaming sectors is difficult enough without significant internal division.

Foolish final thoughts
Expecting Microsoft to significantly outperform the market going forward may be overly optimistic, but the company has appeal as a more conservative investment. Those who already have a position in the company can look to its cloud efforts as a path to growth, but investors on the outside looking in may want to wait for a more attractive entry point.

Leaked: Apple's next smart device (warning, it may shock you)
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Keith Noonan has no position in any stocks mentioned. The Motley Fool recommends Apple, Google (A shares), and Google (C shares). The Motley Fool owns shares of Apple, Google (A shares), Google (C shares), and 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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