That's a Lot of Surface Tablets

Is it too many?

Evan Niu
Evan Niu, CFA
Oct 16, 2012 at 8:05PM
Technology and Telecom

Spoiler alert: this holiday season's theme will be all about tablets. That's especially true when you consider how much lower the price points for entry-level tablet are this year relative to last year.'s (NASDAQ:AMZN) first-generation Kindle Fire was the e-tailer's "#1 best-selling, most gifted, and most wished for product" in the fourth quarter, as the leading 7-inch tablet at the $199 price point. That same model has now gotten a spec bump and price reduction, while Google (NASDAQ:GOOGL) has entered the 7-inch fray with the Nexus 7.

Mr. Softy wants some
(NASDAQ:MSFT) is set to launch its Surface table family next week. While its entry-level price points have now been revealed to start at $499, the software giant is reportedly still betting it can move a fair amount of these devices. The Wall Street Journal says that Microsoft has ordered between 3 million and 5 million Surface units from its suppliers, which is approximately on par with how many Kindle Fires and Nexus 7s that Amazon and Google have ordered, respectively.

Source: Microsoft.

Surface production started earlier this month in preparation for its Oct. 26 launch, incidentally just three days after Apple's (NASDAQ:AAPL) iPad Mini event takes place. Apple could even rain on Microsoft's tablet parade in some form or fashion if it chooses to either launch or begin preorders for the iPad Mini on the same day. Apple has reportedly ordered up a whopping 10 million units of the smaller device, a pretty big bet when you compare its historical unit sales figures.

For context, if Microsoft is hoping to sell between 3 million and 5 million units, that means the software maker thinks its tablet launch can be about as successful as the original iPad's, which sold 3.3 million units and 4.2 million units in its first two quarters, in that order. Of course, there are some notable differences: the iPad launched in a calendar second quarter instead of the holiday fourth quarter and broader tablet adoption has come a long way since then.

A grim reminder from RIM
With its jump into first-party hardware, Microsoft will have to cope with something it's not particularly used to: inventory management. Right now it has $1.1 billion of inventory on its books, which likely includes a bunch of Xboxes and keyboards. That's less than 1% of total assets, unsurprising since its primary product is software.

Microsoft doesn't have experience with massive physical product rollouts. The company sold 13.7  million Xbox 360 units last fiscal year but the Surface tablets will retail for over twice as much and Microsoft certainly hopes it will quickly grow into more unit volumes.

If it turns out that Microsoft is betting too big here and those Surface units sit on store shelves collecting dust, the company could face a big writedown further down the road. Remember last year when Research In Motion (NYSE:BB) ate a pre-tax noncash charge of $485 million because it had a "high level of BlackBerry PlayBook inventory" that needed "an increase in promotional activity" to clear out? That writedown required the BlackBerry maker to tone down its earnings guidance and triggered a mean sell-off.

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The last thing that Microsoft (or anyone) wants right now is to be like RIM.

A bold prediction
Surface launches next Friday, which will leave just over two full months in the fiscal quarter before the year closes. No tablet that has tried to compete directly with the iPad on price has been able to move the needle in unit volumes. If it turns out that the company has ordered this many Surface units, mark my words: Microsoft will eat an inventory writedown in the not-too-distant future.