Microsoft’s Tablet Headwind Could Hurt Its Stock

December 20th, 2010 by Trefis Team
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According to a New York Times report, [1] Microsoft (NASDAQ:MSFT) is expected to unveil tablet PCs utilizing a customized form of its Windows 7 operating system at the 2011 Consumer Electronics Show in Las Vegas. According to the report, the tablet devices will be built by Samsung (SEO:005930) and Dell (NASDAQ:DELL), and will feature Windows OS. With this release, Microsoft hopes to compete with Apple (NASDAQ:AAPL) iPad. However, we believe Microsoft may struggle in its attempt due to a few key headwinds.

Microsoft is reportedly working on development of Windows 8, which will be better suited for touch screen tablet devices. However, Windows 8 is expected to be released by 2011-end, by which time the tablet market will be more competitive, with Google (NASDAQ:GOOG) Android tablets, Research in Motion (NASDAQ:RIMM) PlayBook tablets, and Apple iPad expected to capture most of the tablet market. We believe Microsoft’s weak strategy and late entry into the tablet market could hurt its sales, which could weigh on its margins.

We estimate that Microsoft’s Windows OS generates roughly 42% of the company’s stock value. Our price estimate for Microsoft stands at $31.56, roughly 13% ahead of market value.

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Microsoft Faces Headwinds in the Tablet Market

As discussed above, Microsoft plans to launch tablets on a customized version of Windows 7. Even though Windows 7 OS was successful on PCs, a tablet requires a completely different OS. The most important aspect for a tablet is the compatibility with touch screen interface, and the customized version of Windows 7 may not provide the same effect. [2] Another factor is the OS compatibility with tablet processors. The Windows OS compatibility with Intel (NASDAQ:INTC) processors on PCs is well known. [3] However, most of the tablets are equipped with ARM processors, [4] and hence the Windows OS would be required to be tweaked in order for it to work with the ARM processor. [5] Windows 8 should fit these basic requirements for a tablet, but by the time it’s ready by 2011-end, Microsoft would have to navigate much higher competition.

Downside to Microsoft Stock

[trefis_forecast ticker=”MSFT” driver=”0642″]

As discussed above, Microsoft could struggle in the tablet market due to a weak strategy and late entry into the tablet market. There is a risk that Microsoft could end up incurring more R&D and marketing expenses to compete in the tablet market. This could pressure margins in the long term. We expect Microsoft’s OS operating margins to decline from around 79% in 2007 to around 64% in 2010, and to continue to decline to around 60% by the end of Trefis forecast period.

There could be a downside of 10% to our estimate for Microsoft’s stock if Windows OS margin declines to around 45% by the end of Trefis forecast period, instead of the 60% that we forecast.

You can see the complete $31.56 Trefis Price estimate for Microsoft stock here.

Notes:
  1. Microsoft to announce new slates targeting iPad, New York Time, December, 2010 [↩]
  2. BusinessInsider report, December, 2010 [↩]
  3. Windows 7 works on Intel processors, but does not work on ARM processors, PCWorld, November 2010 [↩]
  4. Apple iPad based on ARM processor, AppleInsider, January, 2010 [↩]
  5. BusinessInsider report, December, 2010 [↩]