Microsoft (NASDAQ:MSFT) is set to announce its Q3 FY 2013 earnings on Thursday, April 18. The company posted good results last quarter, but we are concerned about weak PC shipments in the current quarter and its effect on the Windows division. ((PC Shipments Post the Steepest Decline Ever in a Single Quarter, April 10 2013, www.idc.com)) In Q2 FY13, Microsoft sold over 60 million Windows 8 licenses, and we will closely monitor the impact of PC sales on the Windows OS division.  Additionally, we will also keep a close eye on the sales of the newly released Microsoft Office 2013 and revenue from the server division in the upcoming earnings announcement.See our complete analysis of Microsoft here
Recap Of Q2 FY2013 Earnings
Total revenues increased to $21.5 billion, 3% higher than $20.9 billion the company posted during Q2 FY12. However, operating income fell to $7.7 billion, a drop of 2.7% y-o-y on higher sales and marketing costs accrued due to the Windows 8 launch. Microsoft’s revenues from its Windows division increased by 24% y-o-y to $5.88 billion. Additionally, server and tools revenue grew 9% driven by growth in SQL server and Windows server.
Impact Of Weak PC Sales On Windows OS
Windows Operating System is Microsoft’s third largest division and makes up around 14% of its stock value. In 2012, the company generated approximately $18 billion from this division, selling each Windows license to OEMs for $52 on average.
For Q1 CY13, IDC reported a 14% y-o-y decline in PC shipments. Moreover, Microsoft sold over 60 million licenses last quarter and since then Windows 8 sales have cooled down. Lower PC sales and a decline in the adoption of Windows 8 may have significantly impacted revenues of Windows OS division. In order to boost sales and maintain market share, Microsoft is offering discounts on Windows 8 prices to OEMs. We are keen to know if Microsoft was able to buck the trend by adopting these measures. We expect the company to disclose the number of licenses it sold in Q3 and will keep a close eye on this number.
Office 2013 Release To Bolster Revenue
Microsoft’s biggest revenue driver is its Office productivity suite and makes up almost 40% of its stock value according to our estimates. This segment generated approximately $24 billion in revenue in 2012, and we expect this to grow to $27 billion by 2016. At 60%, this division has the highest margins for Microsoft, primarily due to a dominant 93% market share in the productivity suite market.
During Q2 FY13, Microsoft reported 18% bookings growth and near historical high renewal rates for Office. In January this year, Microsoft launched its Office 2013 software. We believe that the successful adoption of Office 2013 is critical for Microsoft to maintain its market share in the future. In the upcoming earnings announcement, we expect Microsoft to disclose the sales number for the newly released Office 2013, and we expect bookings growth to continue as clients adopt the feature-rich, cloud-compatible Office 2013.
Windows Server To Provide Growth
Microsoft’s Windows Server division is the second largest business unit, making up around 22% of its total value. This division has been the fastest growing division and saw 9% growth in Q2 FY13 driven by SQL server growth. Many Microsoft customers depend on SQL servers for mission critical and business intelligence needs, specifically in the big data analytics domain.
Besides being a growth driver, the server division is key for Microsoft’s long-term prospects as it will help cross-sell other products. If a company uses the Exchange server, it has higher chances of using Windows-based PCs and will prefer that its employees have other Microsoft products such as the Windows Phone and the Surface tablet to ensure seamless compatibility.
We will closely watch Windows Server sales as this division also has the potential to become a cash cow like the Office and Windows divisions.
We currently have a $41 price estimate for Microsoft, which is approximately 40% above the current market price.Notes: