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Five questions financial analysts should be asking Microsoft

Will analysts pressure Microsoft's in the right ways at the company's annual meeting with them?

On Thursday Microsoft will reveal its annual earnings via its full-disclosure filing with the SEC (the 10K) and its annual financial analyst meeting. Microsoft last week announced its earnings -- (via an 8K filing) and the news was not good, a 29% dive in profit. We can only hope that its past two painful quarters will serve as a wake up call. But first, someone needs to set the wake-up call alarm. That someone is supposed to be the financial analyst community. What shareholders and end users want to hear are answers to the tough questions.

The following is a list of such questions, written by a guest blogger, the Crandrea Group's Craig Montgomery, a shareholder activist campaigning for a change in Microsoft strategy:

Microsoft stock has languished for approximately a decade. Recently, CEO, Steve Ballmer, has blamed the company's poor performance on the economy. The Wall Street Journal reported on the company's significant declines in revenue and earnings. The company has been scrutinized by analysts, reporters, shareholders and consumers. But company leadership has been able to re-direct criticism. More recently the media and analysts are stepping up their questioning, even going so far as to question Microsoft’s future potential. Wall Street has referred to Microsoft as a utility, which is not a flattering analogy of a company which was once a Wall Street “darling.” If Microsoft wants to been once again seen as growth company, and not a utility, it is time to hear better answers.

1) What is the company doing to offset the decline in operating system revenue? less annuity revenue for Microsoft to insulate its revenue and earnings level.  

Microsoft has historically relied upon its cash cows to sustain revenue and earnings. The company has essentially become dependent on its operating systems from its Products and Services Division. However, there has been an increasing trend towards netbooks. Microsoft is confronted with a tremendous dilemma concerning the mini-notebooks that consumers seem to love. Many netbooks are powered by Linux, not Windows. But this isn't just a new form of PC. Netbooks are replacing higher-margin desktops and notebooks. The Consumer Electronics Association just released a report stating that this trend should continue. When Windows is selected as the operating system for a netbook, Microsoft earns less income for each copy of Windows sold on a netbook.

This means that the company is now growing more reliant on its Client ,and Server and Tools Division for revenue. However, if the netbook and handheld trend continues, there will be

2) What is the company doing to offset the decline in its Business Division?

The Business Division has also provided the company with a large portion of revenue. This division incorporates products such as Word, Excel and PowerPoint.   In December 2008 this division equated to over $4 billion in revenue, according to company results. But at that time, this division also reported a decline of five percent.

This division is confronted with increasing competition such as Google Docs, and OpenOffice.org. These competitors are being offered for free. Microsoft needs to explain what it will do to convince users to pay for its product instead of adopt a similar one for free. From an enterprise standpoint, the growing trend of SaaS also has the capacity to threaten Microsoft. IT professionals think of SaaS as a lower-cost way for businesses to obtain rights to use software as needed versus licensing all devices with all applications. The on-demand licensing enables the benefits of commercially licensed use without the associated complexity and potential high initial cost of equipping every device with the applications that are only used when needed. This trend could fundamentally cause a substantial decline in Business Division revenue.

3) What is the real plan regarding mobile?

Reports find consumers are increasingly using smartphones instead of PCs. BlackBerry and iPhones are popular, but Microsoft is languishing within this sector. iPhones in particular threaten Microsoft because of the rate of adoption. In 2009, Apple experienced a 88 percent increase in the number of units sold. Also, as Apple continues to offer more applications it will continue to threaten Microsoft. If Microsoft can't figure out a way to compete within mobile, it will surely be hurt.

4) What is the company plan for its Entertainment Division?

This division is responsible for its gaming platform which involves the Xbox 360. In the third quarter of 2009, this division generated approximately $1.6 billion. However, this is a decrease from $3.6 billion in the previous year. It is uncertain the capital deployed developing Xbox (reading Mini-Microsoft provides insight into the tremendous capital) yet the division fails to compete with PlayStation and more recently Wii. It is estimated that Wii controls approximately 45% of the market.

Microsoft has decreased the price of Xbox. This tactic or strategy will potentially sell more units. This is great if you only announce the number of units sold. The company could technically state that it has moved more units. But this tactic also cuts into profits. Is it prudent for Microsoft to continue to deploy hundreds of millions (potentially billions) towards this segment or should it recognize that its losing the battle in this sector similar to losing in its online division?

This ultimately leads to the next question.

5) What is the company plan with its Online Division?

Once upon a time, Microsoft defeated Netscape. Today, Microsoft reportedly controls approximately 10 percent of the online market. Recently, Microsoft released its “new” search engine Bing. The company hailed and promoted it as the best search engine. The company intends to spend $100 million to advertise Bing. The initial reports indicated that share increased by approximately 3%.

Please note, that the $100 million only relates to advertising expenditure. It fails to incorporate the capital deployed on R&D. The advertising campaign has increased share but it fails to compete with Google that has over 60% of the market. Yesterday, it reported an agreement with Yahoo that reports say will still give it a mere 30% of the market, to be shared with Yahoo. Why would Microsoft spend R&D to create Bing, spend $100 million on advertising and then do a deal with Yahoo? The message is "We have better technology, we are better than Google, but, we need Yahoo to compete." 

If Bing was truly the next thing, then you don't need a deal to compete.  Truly the strategy doesn't make sense. But, nothing Microsoft has done in the past decade has really made any sense.

There are numerous other questions that analysts could (and should) ask Microsoft. Such as ...

What is the company doing with Zune?

What is the company going to do to utilize its cash reserve and enhance value?

Why is Mr. Ballmer still the CEO?

Why is there no leadership and accountability within The Boardroom?

Hopefully, analysts will ask the SLT some hard questions. It is time that major shareholders (institutions, mutual funds, hedge funds) stop being content with average results and dividends and ask some tough questions.  It time that Mr. Ballmer and the senior leadership team be put in the “hot seat” and be asked some serious questions concerning the company direction. If they fail to answer accordingly, its time that shareholders demand someone else sit in the CEO’s seat.

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