With the Windows 8 operating system being central to Microsoft’s (NASDAQ:MSFT) strategy over the coming years, we think it is worth examining the impact that a potential failure of the product could have on Microsoft’s value. This is especially relevant since Windows 8 has been getting mixed reviews from critics overall.
What may come as a surprise to many, our analysis shows that even if there is a drastic decrease in Windows-based revenue due to the failure of Windows 8, the resulting price estimate for Microsoft would still be around 25% above the current market price of $29. In our analysis, we took into account the impact of (1) a decrease in Windows market share, (2) a decline in Windows pricing, and (3) a decrease in Microsoft Office market share.
(1) Windows Market Share Falls to 60% by 2019 – 5%
According to our estimates, the Windows Operating division currently makes up approximately 24% of the company’s value. In our model, we currently forecast that Windows market share among PCs will stay relatively flat around 70% until the end of our forecast period.
If Windows 8 is not a success among customers, we think the increasing popularity of platforms such as Apple’s (NASDAQ:AAPL) Mac OSX and free open-source operating systems such as Linux could cause its market share to decline rapidly. In this scenario, if Windows market share falls to around 60% by 2019, our price estimate would decrease by 5%.
(2) Windows Pricing for PC Makers falls to $30 Per License – 5%
Due to the intense competition in the PC OS industry and the advent of tablets which will likely decrease PC prices, our base case forecast estimates the price that a PC maker pays for the Windows license will decline from $55 in 2012 to around $48 by 2019. However, if Windows 8 OS fails to gain the same traction that previous versions of Windows have had, we could see the pricing for PC makers fall to around $30 per license by 2019. If this happens, our price estimate would fall another 5%.
(3) Microsoft Office Market Share falls to 75% – 5%
Our base case model assumes that the Microsoft Office productivity suite is the biggest contributor to the firm’s value at approximately 35%. Since the use of Microsoft Office is correlated with the OS installed on personal computers, we will see a decline in Microsoft’s market share if the use of Windows declines. In the scenario that Windows loses market share and Microsoft Office’s market share falls to around 75%, our price estimate for the company would fall another 5% to around $36.
While there are product lines we haven’t considered, such as the Windows Phone and the Surface tablet, which would also suffer due to the failure of Windows 8, our analysis shows that Microsoft would still remain undervalued in terms of estimates. Even if Windows and Office lose market share, the company can mitigate the impact due to its relatively diversified revenue streams; the Server division makes up 20% of the company’s value at present.
We believe Microsoft has the experience of handling a failed OS launch, which was demonstrated by its transition from Vista. If Windows 8 goes down the same road, we think the company will be able to weather the storm and minimize any impacts to its stock’s value.