MSFTextrememakeover

Thursday, January 24, 2008

Q2 FY08 Earnings

Preview:

Stakes heading into MSFT's report are about as high as I can remember. The punishment for companies who disappoint this earnings season has been swift and severe - just ask INTC or AAPL holders. Additionally, you have markets that are on the edge of the abyss. At the lows yesterday, the Nasdaq notched the 20% decline that signals a bear market - and the Dow and S&P weren't far behind. Luckily, buyers waded in and the subsequent rally managed to turn it into a reversal day. But signs increasingly point to the demise of the bull market that began back in 2002.

For its part, MSFT has held up amazingly well during this market meltdown. Although significantly off its recent highs, it's substantially above the $28.60 or so level it would be at had it just performed like usual (i.e. at or below the index). The risk, of course, is that we'll end up there shortly if the market takes exception to anything said tonight. Alternatively, if MSFT impresses, maybe we rally a buck and give the rest of tech at least a short term boost as well.

As a reminder, consensus is as follows:

  • Revenue: $15.95B
  • EPS: .46
See more background here:
The most important figure - guidance for the year - was:

  • Revenue: $58.8B-$59.7B
  • EPS: $1.78-$1.81
If MSFT backs away from that at all, we're done. Q3 compares are also going to be ugly given the benefit realized last year from the deferred Windows and Office revenue. As per usual, if the market likes the report and guidance overall, then what is primarily an accounting/timing issue will be given a pass. Otherwise, we'll see headline after headline tomorrow about "slowing growth". FWIW, Goldman is banging the drum and getting "conviction" about MSFT again ahead of earnings. They called it right last time, although their conviction was short-lived - more like an infatuation. So let's see if [newer] analyst Sarah Friar can make it 2:2, following Rick Sherlund's disastrous 0:30 record previously.

I'll be back after earnings to update this post. Meanwhile, you can check out the recent Motley Fool bull versus bear debate on MSFT, or join me in scratching your head over this development.

Results:

Very strong. Looks to be a beat of consensus and whisper numbers on both the top and bottom lines, along with raised guidance for the full year:

  • Revenue: $16.37B
  • EPS: .50
Guidance for the year:

  • Revenue: $59.9B-$60.5B
  • EPS: $1.85-$1.88

Stock is up $1.50 to $34.75 currently in AH. Back with more commentary after the cc.
 
Conference Call and 10Q analysis:
 
  • 15% growth overall (net of technology guarantee impact)
  • $4.1B in buybacks during the Q (leaving $8.7B remaining on the previously approved $36.2B)
  • Online advertising growth of 38% (26% excluding AQNT)
  • Online expenses grew even faster though
  • E&D managed its third ever quarterly profit and first back to back one (now just $5.4B to go before breakeven)
  • Cost of revenue dropped from 29% to 22% during the Q (yielding 21% vs 23% YOY half way through the fiscal)
  • Result: operating margins increased 4% to 40%
  • SharePoint grew 50% during the Q, as did Office Communication Server 
  • Dynamics customer billings up 26%
  • 427M Windows Live ids from 352M last year
  • 22nd consecutive quarter of double-digit revenue growth for Server & Tools (very impressive)
  • Over 60% of sales from users and regions outside of the US (emerging markets up nearly 30%, non-US mature up 20%)
  • Unearned revenue down sequentially, but up YOY ($12.178B vs $11.861B) and $500M more than forecast
  • R&D up 15% on the Q to $1.885B from $1.637B, but down a point as a percentage of revenue (and no, I'm no clearer on the value received for money spent)
  • Cash + short term investment down to $21.1B from $23.4B
  • Expect PC growth for the year to be 11-13% now (up 1% from previous)
  • Diluted shares outstanding decreased to 9.503B from 9.942B
  • Total stockholder's equity up $3.33B to $34.431B
  • Not immune to global economic factors, but haven't seen any negative spillover from a weakened US economy (yet)
  • Currently under audit by the IRS for tax years 2000-2006? (I must have missed this one previously)
Short version: strong results, increased guidance, generally upbeat tone, and no really embarrassing items for analysts to question. Good job! Yes, online continues to be a sinkhole for cash. But everyone is used to that by now, and at least the top line result is semi-respectable. Yes, there's still no color on actual large scale Vista deployments. But at least client revenue and unearned remains solid. Bottom line, if last report was sufficient to get some investors to take another look at MSFT, then this one should attract others and perhaps reduce doubts that last time was merely a fluke. 
 
Stock now up $1.59 to $34.84 in AH. We'll see what happens tomorrow in the regular session.
 
Update:
 
Mini has a good selection of the post earnings reviews that I normally provide here. So I won't bother duplicating that, although I'll offer one more just because I like the title:
 

On the less-positive but still worth reading side, Henry Blodget drills into the online numbers further:

For its part, the stock opened strongly ($34.90) but has given back much of that gain currently ($33.54). Volume is very high (already surpassed average daily volume).

12 Comments:

  • what is the value of a business which can make $357m in a quarter?

    it is not clear whether e&d can keep it up or not. in such cases expectations are used.

    if e&d can keep up the same level of profitability then such a business is worth tens of b.

    so you are a fool if you ignore the value of a business being created in your p&l calculation.

    if you invest $35 to buy a share of msft. by your logic you will take 100 years to make a profit. and you will never make it if you buy a non-dividend paying stock such as appl or goog. man you are a fool. missing even the basics of finance.

    By Anonymous Anonymous, at 7:20 PM  

  • Online is such a cluster its unbelievable.

    Its respectable topline is not because of any stroke of genius or organic growth -- its the Aquantive acquisition and the partner deals digg, facebook etc that are making the topline growth look respectable. The increasing -ve bottomline is because most of these deals are likely -ve.

    If we strip these deals away I'd wager YOY this group has not even kept pace with growth in ad market.

    By Anonymous Anonymous, at 10:01 PM  

  • "so you are a fool if you ignore the value of a business being created in your p&l calculation."

    In your usual infantile way, I assume you're referring to my comment about $ required for E&D to get to breakeven on an operational basis? If so, the numbers I provided are accurate. In fact, they're understated since they reflect direct reported Xbox losses only. WRT ignoring the value of the business being created, I have posted extensively on the subject of alternative approaches to valuing Xbox when that was the topic at hand. WRT the quarterly result for E&D, it's stronger than I expected and encouraging if sustainable.

    The bottom line is that after plowing through $20B of ongoing investment and costing shareholders some $6B in losses, Xbox might - now that a $1B+ warranty charge taken at the beginning of this fiscal has been retroactively buried into FY07 instead - notch its first ever annual profit since launch in 2001. Most companies work on total payback timeframes of 7 years or less. Not 7 years just to begin paying back the investment.

    By Blogger MSFTextrememakeover, at 10:38 PM  

  • "If we strip these deals away I'd wager YOY this group has not even kept pace with growth in ad market."

    That's probably a safe bet. But I'm still hoping that AQNT and others will help them turn it around - at least sufficiently to try and catch YHOO.

    By Blogger MSFTextrememakeover, at 11:32 PM  

  • are you a fool to get fully paid on your investment in 7 years or less?

    suppose ge decides to buy msft at $300b. how many years will ge take to get back its investment of $300b?

    tell me a company whose profit is not expected to shrink and has a pe ratio of 7? you should only invest in that company.

    By Anonymous Anonymous, at 6:43 PM  

  • "are you a fool to get fully paid on your investment in 7 years or less?"

    The topic was Xbox and business investment payback periods. Seven years or less would be the norm. In rare cases, a 10 year payback. Xbox will easily exceed the latter - and by a wide margin.

    "suppose ge decides to buy msft at $300b. how many years will ge take to get back its investment of $300b?"

    See above.

    "tell me a company whose profit is not expected to shrink and has a pe ratio of 7? you should only invest in that company."

    According to the Stock Screener on MSN Money, there are at least 5 that match your criteria currently.

    By Blogger MSFTextrememakeover, at 10:20 AM  

  • Do you have any read on churn in institutional/fund holdings over the last quarter?

    By Anonymous Charles, at 7:46 AM  

  • "Do you have any read on churn in institutional/fund holdings over the last quarter?"

    Nothing outside of moneyflow (which has been negative since Dec, although yesterday it was the top inflow stock among decliners) and resources like this:

    MSFT Ownership

    But they sure played us for a nice pump and dump at earnings :-)

    By Blogger MSFTextrememakeover, at 8:10 AM  

  • "Online is such a cluster its unbelievable.

    Its respectable topline is not because of any stroke of genius or organic growth -- its the Aquantive acquisition and the partner deals digg, facebook etc that are making the topline growth look respectable. The increasing -ve bottomline is because most of these deals are likely -ve.

    If we strip these deals away I'd wager YOY this group has not even kept pace with growth in ad market."

    MSN has been profitable for some time. Unfortunately, it has the live.com millstone around its neck (which even after pirating Hotmail, Messenger and MapPoint, still can't get its financial house in order). Let's place blame appropriately, hmmm?

    By Anonymous Anonymous, at 12:19 PM  

  • I can't wait to hear what MSFTextrememakeover has to say about a potential Yahoo acquisition!

    Right now my mind is reeling at the thought of it.

    By Anonymous Anonymous, at 3:08 PM  

  • Right now my mind is reeling at the thought of it.

    You and the rest of the world+dog. The announcement alone cost MSFT shareholders nearly $20 billion.

    Still searching for some positive analysis on this mind-boggling move...

    By Anonymous Anonymous, at 7:33 PM  

  • Microsoft's Online Division: Flat Growth Rate, Still Burning Cash

    Ballmer: "I know! Dude, feel me... We'll spend $44B on Yahoo!!!"

    Microsoft's acquistion of Yahoo is the quintessential double-edged Caliburnus.

    It's an epic move. Success would bestow legendary 'gravitas'. The attempt is inevitable.

    The attempt is also highly, highly problematic for Microsoft, as everything pivots on execution for which Microsoft is notoriously inept.

    There are many things Yahoo does far better than does Google, increasingly in the quality of search results (though Google's quantity and reach is still broader), and customized news with stats. The jury is out on email, as Google's offering is improving rapidly. And seemingly everything Yahoo does outshines the comparable MSN offering, especially market share.

    So, it is attractive, for someone.

    But there seems little Microsoft can add except cash (read staying power) and maybe channels, and it isn't clear that's what Yahoo lacks most, but rather a profitable strategy (another Microsoft weakness). Fixing Yahoo seems to require a better understanding of online advertising and commerce, and frankly it isn't clear to me that anyone has that cornered; not Google, not Yahoo and not Acquantive/Microsoft/MSN (successful advertising management has often seemed a mystic craft benefiting more from luck and agility than from competance and foresight).

    If Microsoft had a track record of successfully integrating, acreting and growing its acquistions instead of just embalming them, and if it demonstrated better customer rapport, wasn't already spread too thin across diverse and poorly run LOBs, wasn't top-heavy with sycophants, and had good execution (of projects, not people), it could work.

    Then if the acquistion goes through, it is difficult to imagine some aspect of Microsoft not suffering significantly as its myopic focus is spread thinner and wider. Not paying attention to a $44B acquisition would be suicide, but losing focus on the other problems will also be suicide. Avoiding both is fraught with uncertainty, to put it charitably.

    It has attractive possibilities, arguably essential, that in the hands of an Oracle or Cisco would be an odds on bet. But in the hands of the Redmond "double down and bet bigger" echo-chamber.... well, one might be advised to sell their MSFT now and buy their bonds instead.

    When stepping out onto thin ice, it's best to shed weight and distribute evenly.

    By Anonymous Charles, at 8:16 AM  

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