Saturday, April 26, 2008

Earnings Show Microsoft Needs Yahoo

During a speech in Milan Apr. 23, Microsoft CEO Steve Ballmer said he's prepared to walk away from the company's takeover offer for Yahoo!, which has rebuffed the advances. Not so fast, Microsoft. Quarterly results reported the following day reinforce why Microsoft (MSFT) could use the growth Yahoo (YHOO) would provide.

Microsoft posted an 11% drop in profit and flat sales for the quarter ended Mar. 31. Microsoft relied on overseas operations and sales from smaller divisions to offset weakness in its flagship PC products. "It wasn't a spectacular quarter by any means," says Brent Thill, director of software research at Citigroup (C).

Profit Declines, Revenue Flat

Sales had been unusually high a year earlier, when Microsoft booked $1.6 billion in revenue from previously sold coupons for its new Windows Vista operating system and a new version of its Office productivity suite. Fiscal third-quarter profit fell to $4.41 billion, or 47¢ a share, from $4.93 billion, or 50¢ a share. Revenue was little changed at $14.45 billion, according to results released after the close of trading on Apr. 24. Analysts had expected per-share earnings of 44¢ on sales of $14.49 billion.

Excluding the benefit from the coupons, third-quarter sales would have risen 14%, Microsoft said. And the results would have been even worse if not for a 68% increase in sales in the company's Xbox division, a strong performance from the group that makes corporate server software, and the strength of Microsoft's international business, which accounts for 60% of sales.

Equally troublesome, Microsoft said this quarter's per-share profit would be 45¢ to 48¢, compared with a Wall Street consensus estimate of 48¢, says Charles Di Bona, a senior equity analyst at Sanford C. Bernstein. The earnings follow two quarters of strong gains in sales and profits.

Economic and Competitive Worries

Chief Financial Officer Chris Liddell, during an Apr. 24 conference call with investors, said Microsoft's diverse range of markets and products have kept its business healthy amid a weakening U.S. economy. Still, the results raised concern about the company's ability to continue weathering the slump, especially in light of rising competition from Google (GOOG), which controls the market for ads pegged to online searches, and is encroaching into Microsoft's markets with online software for e-mail, productivity, and other applications. What's more, investors took the results as a sign Microsoft isn't selling copies of Windows Vista as fast as the PC market is growing, and sold Microsoft shares in extended trading. The stock fell $1.58, or about 5%, after closing the day up 35¢, or about 1%, at 31.80.

Microsoft went public with a $31-a-share takeover bid for Yahoo Feb. 1 to try to close the gap with Google. But it has been unable to negotiate a deal and has threatened to take its appeal directly to shareholders if Yahoo doesn't capitulate by Apr. 26. Citigroup's Thill says Microsoft could raise its offer by $1 or $2 per share to close the deal, but adds Yahoo is holding out for perhaps $5 to $10 more. Even a combined Microsoft and Yahoo would be hard-pressed to eclipse Google in the online ad market, he says: "There's still a runaway train they're trying to catch. And they are two little trains trying to hook up."


businessweek.com

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