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Microsoft Counting on Azure and Surface

Posted on Tuesday, Jan 28th 2014

According to the latest Gartner report, Worldwide PC shipments for the fourth quarter of the previous year fell 6.9% to 82.6 million units, making it the seventh consecutive quarter of shipment decline. Despite the holiday season quarter, the researcher found that while sales of technology products in the U.S. and EMEA markets grew, the spending was more focused on tablets. PC sales in the U.S. fell 7.5% to 15.8 million units and in EMEA fell 6.7% to 25.8 million units.

Microsoft’s financials

Microsoft’s (Nasdaq: MSFT) second quarter revenues grew 14% to $24.52 billion, slightly short of the Street’s projections of $24.68 billion. EPS of $0.81 was significantly ahead of the market’s expectations of $0.68 for the quarter.

The quarter’s successful performance was attributed to the strong growth of Xbox sales and the Enterprise segment. By segment, revenues from the Devices and Hardware revenues grew 68% to $4.7 billion due to increased sales of Surface and Xbox consoles. Revenues from other Devices and Consumer segment fell 10% to $1.8 billion. Commercial licensing revenues grew 7% to $10.9 billion and other commercial revenues grew 28% to $1.8 billion.

Among other metrics, revenues from Windows OEM fell 3% primarily due to the declining PC sales. Surface revenues more than doubled over the quarter to $893 million. They also reported sales of 7.4 million Xbox console units of which 3.9 million units were their latest Xbox One consoles. Bing also continued to see strong improvement with search share increasing to 18.2% and search advertising revenues growing 34% over the year. Within the Enterprise segment, they saw double digit growth in SQL Server and System Center revenues. Revenues from commercial cloud services more than doubled and both Office 365 commercial seats and Azure customers grew by triple-digits during the quarter.

For the current quarter, Microsoft projected revenues of $20.0 billion-$20.5 billion. The market was looking for revenues of $21.05 billion.

Microsoft Surface Shines Through

But despite the strong quarter, Microsoft still needs to work some more on their tablets. Success for Surface in the recent quarter is attributed to holiday season sales and the release of the new Surface 2 and Surface Pro 2. Additionally, Microsoft also benefited from their sales partnership with Best Buy. As part of this agreement, Best Buy stores now house a Windows Store within their premises to cater to Microsoft’s devices.

But all of this has come at a cost. Surface sales more than doubled to $893 million, but Microsoft incurred a loss of $39 million on these tablets. For Microsoft to continue to show this growth, they will need to deliver strong sales in the absence of the holiday season rush and will thus depend more on the capability of their operating system. While Microsoft did improve on Windows 8 with Windows 8.1, the reviews for the upgraded OS weren’t all that positive. According to market reports, the key flaws in the OS remain primarily due to the absence of the touch versions of the Office apps. Microsoft’s next version of Windows 8 is expected in April this year and it will be a tough market to deliver to till then.

Overall, Microsoft seems to be headed the right way. Analysts are hopeful of Microsoft’s tablet strategy working in their favor. According to an IDC report, sales from Windows-based tablets grew from 1% in 2012 to 3% last year and are projected to increase to 10% by 2017.

Microsoft Counting on Azure

Within the enterprise segment, Microsoft is counting on the growth of their cloud services segment, primarily Azure. As part of their effort to gain market share from Amazon Web Services (AWS), Microsoft has gotten into a price war with the e-tailer. After Amazon recently reduced prices for cloud storage service, Microsoft joined them in the price reduction. In fact, now storage on Azure is priced even lower than Amazon’s storage pricing in some regions.

AWS next week will host its second customer conference, which is sure to grab headlines and be the center of cloud industry discussion. However, as Amazon continues its run leading the Infrastructure as a Service market, Microsoft has slowly but surely been building up its Windows Azure cloud with the intention of giving AWS a run for its money.

They have also been enhancing the service by adding features such as the addition of virtual machine enhancements that allows customers to use cached versions of apps and virtual machines to help improve performance. Recently, Microsoft also added an automated backup to Windows Azure and included HDInsight, an Apache Hadoop-based big data analytics platform that will help them provide business intelligence tools to their consumers. But Microsoft still has a long way to catch up. According to a Synergy Research report, within the Infrastructure-as-a-Service market, AWS has a 35% market share and all other vendors, besides IBM, have a market share of less than 3%. Within the Platform-as-a-Service market, they are faring marginally better with Amazon at 17% market share and Azure at 14% market share.

Microsoft’s Phone Future Remains Bleak

For Microsoft, their biggest disappointment still remains the mobile phone market. Their purchase of Nokia’s phone business does not seem to raise much hope for their future. According to the latest results, sales of Nokia’s Windows-based Lumia phones actually fell in the last quarter to 8.2 million units compared with 8.8 million units sold a quarter ago. At the time of the acquisition, Microsoft’s calculations had revealed that they would need to sell at least 50 million Nokia smartphones to deliver an operating income break even. During the previous year, Nokia sold only 30 million units. Reaching profitability from their phones division is surely going to be a herculean task for Microsoft.

Microsoft’s stock is trading at $36.81 with a market capitalization of $305.51 billion. It touched a 52-week  high of $38.98 last month.

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