Even though Microsoft’s (NASDAQ:MSFT) third quarter earnings were relatively dismal, they were more or less a non-event. All eyes were on the company’s new product launches as new releases of the Windows 8 operating system and the Surface tablet are expected to provide insights into the company’s long-term health.
Despite the buzz surrounding its new products, Microsoft’s stock has yet to see a rise similar to that of its competitors Google (NASDAQ:GOOG) and Apple (NASDAQ:APPL). It seems the market expects Microsoft’s market share for Windows OS and Office divisions to decline despite the recent announcements and what we consider to be innovative, product launches. In contrast to the market, we think the demand for Microsoft’s flagship products will remain stable and can be a catalyst in the stock converging to our $41 price estimate.
See our complete analysis of Microsoft here
Focus on Customer Experience
Some of Microsoft’s products in the past have been derided for a lack of innovation and usability. However, we think that with the Windows 8 platform, Microsoft is getting on the right track and is focused on providing an integrated and intuitive experience for the user. We think Microsoft’s executive team is aware of and concerned by the tough competition that the firm is facing and will no longer take its market leading position for granted.
As the usability and customer friendliness of Microsoft’s products improve, we expect the company to maintain its market share for the Windows operating system. At present, we estimate Microsoft’s Windows 8 PC market share for 2012 will be approximately 77% and will fall slightly to 73% by 2019. But, even if Windows market share falls to 60% by the end of our forecast period, our price estimate will only fall by a dollar, to $40. This still leaves about 40% upside to the current market price of $28.
The fact that significant upside exists despite a large decline in Microsoft’s market share for a key product gives credence to our view that Microsoft’s stock is, at present, undervalued.
Integration Across Platforms
We think one of the key selling points of the new Windows 8 strategy is the integration that customers will be able to experience across Microsoft products. We think this integration provides significant upside potential, especially in emerging markets. If Windows-based smartphones can gain substantial market share in the growing middle class in emerging markets, we are likely to see first time PC buyers who own a Windows smartphone also buy a Windows PC.
Surface Tablets to Appeal to Enterprises
Due to Windows 8′s tablet friendly UI, we think the new Surface tablet could gain popularity in the enterprise space where Microsoft Office products tend to be heavily used. Windows 8 tablets will provide enterprises a good substitute to tablets released by competitors Google and Apple as they will have an integrated version of the Microsoft productivity suite available.
Management has yet to provide any useful financial guidance on the prospects of the Surface tablet, but we do think that it is capable of posting rapid growth. If successful, enterprises are also likely to substitute their iPhones and Blackberrys for the Windows Phone 8 due to the latter’s integration with PCs and the Surface tablet.
Increasing Competition Poses Risks
We estimate that most of Microsoft’s value comes from its stable flagship products such as the Windows operating system and Microsoft Office. Since these two products already have dominant positions in their respective markets, we forecast relatively flat market share for both going forward. However, if Windows 8 or any of Microsoft’s new launches fail to gain traction, we could see downsides to our market share estimates. This could force Microsoft to cut prices for its products and could cause a decrease in the firm’s operating margin. Also, users lost now are likely to gain familiarity with a different technological ecosystem such as Android, which will inhibit Microsoft’s efforts at attracting these customers in the future.
We currently have a $41 price estimate for Microsoft, which is approximately 40% above the current market price.
