Are Microsoft Corporation Surface Sales Ready to Explode?

The software king is sticking with hardware, including going all in on its faux-tablet.

Tim Brugger
Tim Brugger
Aug 8, 2015 at 11:25AM
Technology and Telecom

Based on Microsoft's (NASDAQ:MSFT) stock performance since announcing its fiscal Q4 earnings on July 21 -- essentially flat after an initial sell-off -- investors weren't overly impressed with its recent quarter. The so-so revenue results in Q4 certainly didn't inspire confidence. But what really got the sparks flying was Microsoft CEO Satya Nadella's decision to take a mammoth hit relating to the deal for Nokia's mobile hardware unit.

When the dust cleared, Microsoft wrote off $7.5 billion as an "impairment charge" last quarter, while also booking a restructuring expense of $780 million. Naturally, many industry pundits suggested the quarter's write-offs were a sign that Microsoft was going to exit the hardware business. But there are a couple of reasons why talk of Nadella and team throwing in the mobile hardware towel are premature.

Picking up steam?
Somewhat lost due to the big hardware writedown last quarter was Microsoft's strong revenue from its Computing and Gaming Hardware division. Nadella wasn't kind enough to break out Surface revenue from sales of Microsoft's popular Xbox gaming console, but the unit as a whole grew a whopping 44% year over year last quarter -- to just shy of $2 billion.

Microsoft's Xbox sales were certainly a big part of its hardware division's good showing. However, Nadella made a point of alluding to strong Surface sales, stating, "Our approach to investing in areas where we have differentiation and opportunity is paying off." The launch of a lower-end Surface model, along with a confident move Nadella recently announced, should keep Microsoft's tablet sales momentum moving in the right direction.

Hitting the streets
The continually improving Surface hardware results are sound in and of themselves. However, they look even more impressive when you consider that until recently, Microsoft had only authorized a couple hundred distributors to get the devices into consumers' hands. And even those limited partnerships represented an increase from just a few select sales arrangements during Surface's "early days."

But that's about to change. With Windows 10 hitting the streets, Microsoft intends to expand its list of Surface reseller partners to "a few thousand" across the globe. Not only does the move bode well for Surface revenue with so many more salespeople getting Microsoft's pseudo-tablets out to the masses -- it also should put to rest the notion that Nadella is turning his back on mobile.

Some more good Surface news
You don't have to search long to find data on the slowing PC market. One key reason for the pressure on Microsoft's stock -- in addition to its Nokia write-off and cloud sales "slowing" to a mere 88% improvement last quarter -- is the ongoing decline in PC sales.

Of course, Microsoft is starting to shift its business away from PCs by becoming a leader in new, burgeoning markets, including cloud, cognitive computing, and business analytics. However, the market for "hybrid" devices -- which should certainly include the Surface line-up, considering its flexibility and portability -- is expected to jump a whopping 70% this year, according to research from Gartner.

If this data were to include Surface -- because the keyboard is sold separately, the Surface isn't officially counted as a hybrid device -- Microsoft's hybrid "ultra-mobile" Surface offerings owned 36% of the market last year, putting it at the top of the list. And that was before the low-cost Surface was introduced and the recent decision to dramatically increase the number of resellers was instituted.

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Microsoft's Surface ducks are in a row. As the fastest-growing segment of the device market continues to ramp up, Microsoft's hardware unit will become more than the after-thought some investors expected -- just as it should.