Microsoft (NASDAQ:MSFT) has been pouring money into its online services division for the past few years. Despite the investment, the division continues to post losses. However, this may be set to change. According to Dave O’Hara, Chief Financial Officer for Microsoft’s Applications and Services Group, the online service is all set to break even in the coming quarter, or so he told investors at the recently concluded UBS conference.
The primary reason for this turnaround is the increasing share of Bing in the search engine market. Over the past few years, Microsoft has deeply integrated the capabilities of Bing into a host of products such as Xbox, Windows Phone, Office and Windows 8. As a result, Bing’s share has increased from 13% in January 2011 to over 18% in November this year.  In this article, we will look at the factors that aided the adoption of Bing and how this will help the online division to turnaround.
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Promoting Bing Through Product Integration
In July this year, Microsoft unveiled its one product strategy.  However, the origins of this strategy can be traced to the integrations of Bing’s capabilities with a host of products.  During the year, Microsoft not only introduced the enhanced search capabilities of Bing for its Windows 8, but also integrated Bing with its Office 365. As a result of this integration, Bing’s market share in the U.S. has increased by 1.6 percentage points in 2013 to 18.1%.  We expect this trend to continue as Microsoft plans to integrate more of its products with Bing.
Improving Performance Metrics To Bolster Division Results
The Online Services Division has negatively impacted Microsoft’s overall profitability as it continues to post operating losses. However, due to rise in Bing’s penetration, the division’s revenues have increased by 15% year over year in the first nine months of 2013, boosted by 47% growth in online ad revenues.  Search ad revenues depend on the number of searches performed on Bing and the revenue per search (RPS). Currently, we project RPS to decline from $16 in 2012 to $11 by the end of our forecast period.
However, the data from comScore indicates that the explicit search queries for Microsoft has been flat at 3.28 billion per month in 2013 so far. Therefore, we can conclude that the revenue per search for the company has increased, which has led to an improvement in the pricing of search key word (also known as Cost per Click). If this trend were to continue in the coming quarters and RPS were to stabilize at $15, our stock price estimate can increase by 5%.
Furthermore, any improvement in RPS can help the company to post operational profit as Bing’s business has high operating leverage, and any further investment in Bing will result in incremental revenues and profits.
We have $42 price estimate for Microsoft, which is approximately 25% above the current market price.Notes:
- Data from comScore January 2011 & November 2013 [↩]
- One Microsoft: Company realigns to enable innovation at greater speed, efficiency, July 13 2013, www.microsoft.com [↩]
- A Breakout Year, December 17 2013, www.bing.com [↩]
- comScore January 2013 and November 2013 data [↩]
- The last three quarter results from company Forms 10-Q & 10-K [↩]