Microsoft (NASDAQ: MSFT), during its most recent earnings announcement, provided encouraging top line growth figures despite posting a GAAP loss. All of its major divisions reported revenue increases in an uncertain macroeconomic environment despite its some of its major products being towards the end of their life cycles.  However, these increases in revenues have not translated into an increase in operating profits for all of the company’s divisions. One in particular, the Entertainment and Devices division has reported an operating loss for the quarter, primarily due to the subsidies paid to Nokia (NYSE:NOK) to carry the Windows operating system on its mobile phones.
Reports state that Windows is paying Nokia $250 million per quarter to carry its operating system on its mobile devices. In return, Nokia will pay a licensing fee of approximately $20 for each phone that it sells, meaning that Nokia will have to sell around 12.5 million phones a quarter for Microsoft to just break even on the subsidies.  This is unlikely to happen anytime soon as Nokia is struggling to sell its Windows based phones; it was forced cut the price of the Lumia in half, hoping that a lower price will kindle demand.
To address this low demand, Microsoft is also appealing to budget and first time smartphone buyers by lowering the manufacturing standards required for using its OS.  While providing phones at a lower price point might not pay off in the United States where smartphone purchases are subsidized by wireless providers, it could help the company gain market share in emerging economies where the prices of high end smartphones represent significant portions of a middle class consumers’ monthly salary.
Regardless of whether or not the demand for the Microsoft mobile OS increases, the profitability of this division will probably have an immaterial impact on Microsoft’s stock value. For example, even a 100% increase in revenue only results in a small increase in the stock price. You can assess the impact yourself by using our tool below:
Judging from how Microsoft propped up the XBox before the Kinect was released, we expect that it will continue to push its mobile platform even if the mobile segment of the business continues to lose money. If the segment is successful, it could entice users to use the Windows OS across all three (PC, tablet and mobile) platforms. We currently have a $41.38 price estimate for Microsoft which is approximately 40% above its current market price.Notes: