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Microsoft Corp. (NASDAQ:MSFT): Why The Fate Of The Stock Hinges On Windows 8

November 29th, 2012

David Zeiler: Any hope of jolting Microsoft stock out of years of stagnation lies with the success of its latest attempts to capture a slice of mobile computing.

Microsoft Corp. (NASDAQ:MSFT) is only a bit player in mobile, currently dominated by devices running Apple Inc.’s (NASDAQ:AAPL) iOS and Google Inc.’s (NASDAQ:GOOG) Android. That’s why the company now has a new mobile strategy, with the focal point being Windows 8, the latest version of Microsoft’s dominant computer operating system.

Windows 8 is optimized for the mobile devices such as tablets and smartphones that have stolen the thunder from traditional PCs, a market Microsoft long dominated.

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Microsoft has also ventured into mobile hardware with its new Surface tablet.

Now Microsoft is betting that the Surface tablet will turn heads and that Windows 8 will put it back in the mobile OS game by luring hardware makers away from Android.

“I don’t control the macro-environment, but there’s a huge opportunity in the explosion of devices,” Microsoft Chief Financial Officer Peter Klein told Reuters. “There’s demand for compelling devices and a connected set of cloud experiences. That’s what Windows 8 is all about.”

The Redmond, WA-based company must succeed in mobile to secure a new source of growth capable of moving Microsoft stock out of the doldrums where it has languished for more than a decade. The current 10-year return for MSFT is -6.39% — yes, negative. Rolling back to November 2001 puts the return on Microsoft stock at -15.75%.

Owners of Microsoft stock can only cross their fingers and hope the bet pays off.

How Mobile Success Could Help Microsoft Stock

Microsoft had little choice but to shift its attention to mobile computing. That’s where the money is in tech today.

Apple’s profits have soared from about $2 billion in FY 2006 to $41.7 billion in FY 2012, almost entirely on the strength of the iPhone and iPad.

More recently, Korean-based Samsung Electronics (PINK:SSNLF) has emerged as the dominant Android hardware maker, with its profits rocketing 91% in the September quarter on strong sales of its Galaxy series of smartphones.

Sales growth in mobile devices has soared over the past few years. Research firm Gartner expects combined global sales of tablets and smartphones to reach 821 million units this year and rise 46% to pass the 1.2 billion mark next year – triple that of global PC sales.

So far Microsoft hasn’t been able to grab much of this market, with its Windows operating systems on just 2.4% of smartphones, and about 4% of tablets.

But these projections by research firm IDC see that changing with Windows 8…

IDC forecasts Microsoft’s share of the smartphone market to grow to 19.2% by 2016 and its share of the tablet market to reach 11% by then.

That could be enough to move the needle for Microsoft stock, especially since it should get an even bigger boost from sales of the Surface tablet.

Teardowns of the Surface show MSFT earning a healthy 46% profit margin on the Surface, or about $230 per unit. That means for every 1 million Surface tablets it sells, Microsoft will rake in $230 million in profit.

Morgan Stanley analyst Adam Holt has estimated sales of 3 million Surface tablets in the current quarter. That would deliver an extra $690 million to Microsoft’s bottom line – good enough to add 8 cents to the company’s earnings per share (EPS).

If the company can build on that in 2013 and perhaps add an even more profitable Surface phone to the mix, it could be a real shot in the arm for Microsoft stock.

Microsoft’s Steep Challenge

While Microsoft has the potential to succeed in mobile, it faces daunting challenges.

For one thing, Microsoft needs to seize market share from two large and entrenched competitors.

That’s why Windows 8 is the most dramatic change to the operating system since Windows 95 more than 17 years ago. But it’s also a huge risk, in that it could well confuse and frustrate long-time Windows users – on both new PCs as well as mobile devices.

Microsoft has also dared to price the Surface on the high end, with a $499 starting price – the same as the full-sized iPad, and well above most 10-inch Android-based tablets, most of which fall in the $300-$400 range. And that price doesn’t include the signature keyboard/cover, which is about $100 extra.

Microsoft’s goal of maintaining a consistent Windows 8 user experience across both PC and mobile devices also has drawbacks.

The Surface RT’s limited version of Windows 8, necessary because of its less powerful ARM processor, can’t run most Windows software. The Surface Pro, due out in January, will use an Intel processor and run the full version of Windows 8, but will be even pricier.

The truth is, Microsoft’s new Windows 8/Surface tablet strategy could well yield big rewards, but carries risks just as big. Yet it is MSFT’s only chance to remain relevant in the post-PC era – and by far the best way to reinvigorate Microsoft stock.

“The tablet platform is a key initiative for Microsoft,” Carl Howe, an analyst with Yankee Group, told marketplace.org. “If it doesn’t succeed there, there’s no place to point to say ‘Oh that’s the big new future for Microsoft.’ This is a bet-the-company initiative.”

Written By David Zeiler From Money Morning

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