Microsoft (NASDAQ:MSFT) launched Windows 8 in October last year but its sales have failed to pick up. While many factors have contributed to the abysmal performance of Windows 8, the chief reason is the decline in global computing device market. Although, Microsoft is set to launch Windows 8.1 in October, we believe that it might not live up to expectations. In this article, we will discuss the factors likely to affect Windows 8.1 sales.
Global PC Sales To Be Weak
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Windows Operating System is Microsoft’s third largest division and makes up 15% of its stock value by our estimates. However, it contributes 25% to Microsoft’s top line. One of the primary drivers for Microsoft’s Windows division is global PC sales. Approximately 65% of total Windows Division revenue comes from Windows operating systems purchased by original equipment manufacturers (“OEMs”) and pre-installed on their devices. 
According to IDC, the global PC sales continue to decline and global shipments were down by 11% in Q2 2013.  Although, IDC expects that PC sales will pick up in the second half of 2013, we think that global PC sales will remain tepid. Currently, we forecast that the global desktop sales will decline by 5% to 141 million and global notebook market will contract by 2% to 198 million units shipped in 2013. Considering this secular decline in global PC sales, we believe that Microsoft will continue to report slow growth in new Windows 8.1 licenses sold in the coming quarters.
Microsoft To Miss Out On The Tablet Boom
One of the primary reasons for decline in PC shipments is the growing popularity of tablets. According to IDC, tablets will outsell PCs by 2015. Additionally, IDC also predicts tablet shipments to exceed those of portable PCs this year. 
While iOS and Android based tablets continue to rule the market, Microsoft’s Windows 8 based Surface tablets have not fared well. According to IDC, Windows based tablet’s market share was 4.5% in Q2 2013.  Additionally, the company had to write-down Surface inventory worth $900 as poor sales continued to affect Microsoft’s performance. Despite offering a 30% discount on its tablets, Surface sales continue to lag the tablet market.
Moreover, most of the hardware vendors such as Asus, HTC and Samsung have scrapped their plans to launch Windows based tablets. These companies cite low demand for devices that use Windows 8’s RT variant as the primary reason. Microsoft is arming Windows 8.1 with the capability to transform a tablet into a full-fledged desktop PC, capable of running Microsoft Office and other desktop apps. However, we believe Windows 8.1 will suffer from the lack of support from original equipment Manufacturers (OEM). Therefore, we think Windows 8.1 will fail to deliver the anticipated growth in licenses from tablets.
A Losing Bet On Touch Devices
Windows 8 represented Microsoft’s attempt to create an operating system that works well on tablet computers, as well as on touch enabled laptop and desktop machines. However, this bet on touch sensitive computing devices has not yielded the desired results. Currently, a touch notebook sells for $699-$799, nearly 50% above the price of a non-touch notebook. According to IDC, touch ready laptop shipments are significantly lower than the initial expectations. While IDC earlier projected touch notebooks to account for 17%-18% of all notebooks this year, it has now revised this estimate to 10-15% of all laptops as customers are hesitant to pay premium prices for touch-enabled laptops. 
Although, Microsoft still believes that Windows 8 sales will pick up once touch PCs gain traction, we believe that customers will continue to shy away from them due to lack of compelling apps. Moreover, the radical tile design of Windows 8 confused consumers and undermined its usability. Therefore, customers might be reluctant to spend additional amount for a feature that they might never use. All these factors have suppressed the license sales of Windows 8. We believe that even with an overhauled Windows 8.1 version that fixes some of the issues of Windows 8, customers will be unwilling to buy such devices.
We conclude that unless widespread use of touch PCs with compelling apps gain traction, Windows 8.1 license sales will be lower than anticipated. Given that PC sales are waning and Microsoft lacks the necessary hardware OEM support, Windows 8.1 might not be a big success in the near future. The first laptops and PCs featuring pre-installed Windows 8.1 are scheduled to go on sale on October 18. We will continue to pay close attention to the numbers of licenses sold for this version of Windows.
We have $41 price estimate for Microsoft, which is approximately 30% above the current market price.Notes:
- 10-K Fillings [↩]
- Lenovo Overtakes HP as the Top PC Vendor While U.S. Shipments Stabilize in the Second Quarter of 2013, July 10 2013, www.idc.com [↩]
- IDC Forecasts Worldwide Tablet Shipments to Surpass Portable PC Shipments in 2013, May 28 2013, www.idc.com [↩]
- Tablet Shipments Slow in the Second Quarter As Vendors Look To Capitalize on a Strong Second Half of 2013, August 5 2013, www.idc.com [↩]
- Microsoft’s bet on touch PCs fails to pay off, August 13 2013, www.computerworld.com [↩]