Microsoft Earning Preview: Windows, OS & Margin Trend in Focus

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Microsoft ( MSFT ) is expected to announce its fiscal year Q3 earnings on April 28th. The key factors to watch for in the release are the performance of Windows operating system (OS) for PCs and smartphones, and the operating margins of the company. Windows OS accounts for roughly 40% of the stock value by our estimates. Microsoft competes primarily with Apple's ( AAPL ) Mac OS as well as open source software companies like Red Hat ( RHT ) and Novell ( NOVL ) in the OS market which it dominates with around 76% market share according to our estimates.

We currently maintain $31.64 price estimate for Microsoft stock , which is about 25% above market price.

Windows OS Continues to Do Well

Last quarter, the company announced that it has managed to sell 300 million Windows 7 licenses since its release last year, making it the fastest selling OS in history. We believe that Windows 7 was primarily responsible for the market share gain for Microsoft last year.

Windows Phone 7, an OS for smartphones, has not gained much traction yet, with Google ( GOOG ) Android, Apple ( AAPL ) and Research in Motion (RIMM) gaining market share at its expense. To put the numbers in perspective, Windows Phone 7 subscriber market share actually declined from 9% in November 2010 to 7.7% in February 2011, according to Comscore. This data looks at smartphones sold in the U.S. However, the company mentioned that 93% of the customers worldwide are reportedly satisfied with the product, which augurs well for the OS from the long-term point of view.

Operating Margins a Concern

We estimate that the company's operating margins declined from around 40% in 2009 to 36% in 2010 primarily due to pricing declines for its OS licenses as it continues its expansion into emerging markets. Microsoft's Office operating margins have declined from around 65% in 2009 to 61% in 2010, and we believe this could continue as it introduces more cloud-based products that will lead to a lower margin product mix.

These could be a worrying sign for Microsoft as it brings out cheaper cloud-based products in order to compete effectively with Google Apps. We discussed this concern in detail in our earlier note titled 2 Microsoft Concerns That Could Deflate Our Enthusiasm .

See our full analysis for Microsoft.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

This article appears in: Investing , Investing Ideas , Stocks , US Markets

Referenced Stocks: AAPL , GOOG , MSFT , NOVL , RHT



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