The Microsoft Machine Keeps Chugging Along

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microsoft_google203.jpgMicrosoft’s cash-cow businesses are kicking into high gear, as evidenced by its most recent blow-out quarter. Sales of Vista was one of the main drivers, despite the issues that led Microsoft to extend the shelf life of Windows XP. More than 80 percent of Vista sales were through sales of new PCs, which shows how powerful that franchise continues to be.

Here are some numbers to think about: Sales for just the Windows PC business alone were up 25 percent to $4.1 billion (with $3.4 billion of that as pure operating profit). Incidentally, Microsoft’s old-school client software business alone is about the same size as all of Google’s (which reported $4.2 billion in total revenues for the same quarter). Another way to put this into perspective is that Microsoft reported about the same total net profit ($4.3 billion) as Google did revenues, and higher net profit margins overall (31 percent versus 25 percent). For a company with $13.8 billion in total revenues last quarter, Microsoft’s 27 percent growth is very impressive. Although Google grew revenues at a much faster 57 percent clip last quarter, in absolute terms, Microsoft added more money to both the top and bottom lines (revenues rose $3 billion for Microsoft versus $1.5 billion for Google, and net income rose $811 million for Microsoft versus $337 million for Google).

But how did Microsoft do in its new businesses that actually compete directly with Google? Not so good. Revenues for online services grew 25 percent to $671 million, but operating losses more than doubled to $264 million. Microsoft’s new advertising business aQuantive, which it acquired in the middle of the quarter, contributed about $80 million of that revenue. For the full year, aQuantive is expected to add $500 million, or one percentage point to revenue growth. So Microsoft still has a long way to go on that front.

Microsoft’s entertainment and devices business nearly doubled its revenues to $1.9 billion thanks mostly to Xbox and Halo 3 (which accounted for $330 million of that). Nevertheless, the division eked out only $165 million in operating profits. Other tidbits from the conference call: Display advertising grew 23 percent, and 400 million people now have a Live ID (up 19 percent)

The most telling exchange on the conference call was between Sanford Bernstein analyst Charles Di Bona and Microsoft CFO Chris Lidell. You really get a sense of how serious Microsoft is about search and online advertising, committing half of next year’s $3.2 billion in capital expenditures to the data centers it needs to compete (via Seeking Alpha):

Charles Di Bona – Sanford Bernstein

I guess no surprise here, but I’m going to go back to the well on OSB [Online Services Business]. It was probably the only division that didn’t really outperform significantly, only about 10% growth, excluding aQuantive, and the comScore share is back down to sort of the lows that they were in your fiscal Q4.

Especially in light of yesterday’s announcement around Facebook, maybe you can give us a little insight into the strategy and execution here, and is there any shift towards sort of buying traffic and community rather than building it internally? And in general, how do you go balancing those two alternatives and valuing those two alternatives?

Christopher P. Liddell

First thing to note obviously is we met expectations, so it wasn’t a beat, I agree, but it was a meet, so start with that.

Underlying business growth or revenue growth, you mentioned the 10%, which is correct. Clearly in this case it’s a negative from the Access business going away, so — if you look at underlying revenue growth, underlying advertising revenue growth, it grew in the mid 20s, around 25% for the quarter year on year, which we think is acceptable. It’s not certainly stellar. We’d like to see it higher but it’s acceptable and it is higher than where we guided at the start of the year, roughly speaking. So I think reasonable progress on the organic side of the business.

In terms of putting the building blocks in place and how we trade off organic growth through inorganic growth, it’s both. The strategy has been both and will continue to be both, so we are investing heavily in the organic aspects of the business, so a lot of investment in particular has gone into the search product itself, and we clearly are extremely happy with the improvements we are seeing on aspects like relevance, which are critical going forward. We are putting a lot of investment into things like data centers, which are creating the platform of the future and the experience, so we are increasing CapEx quite considerably there. We are looking at CapEx overall for the year of $3.2 billion to $3.3 billion, about half of which is going into the OSB area. And we are putting investment in some of the verticals that I talked about on search organically and all the other areas as well, content on the display side.

So there’s a strong organic side, there’s a strong inorganic side, but clearly aQuantive is the most obvious representation of that and we’re particularly happy that we not only closed aQuantive but we’ve retained all of the employees. We think that integration has gone extremely well and we believe that’s going to generate some significant benefits going forward.

We also did some other smaller acquisitions, ones which we think are important for the ad platform, like AdECN during the quarter, and then the announcement yesterday on Facebook, which is a willingness on our part to make a commitment to a multi-year agreement with a partner who we think has got some tremendous growth opportunities.

So we are willing to do both. We are quite clearly willing to suffer an operating loss in that position as a result of those commitments, and we’ll share that there I think both in our financial analyst meeting and in our guidance.

But to date, in terms of underlying financial metrics, we’re on track. In terms of some of the other things that we wanted to do, if anything we are slightly ahead of where we would like to be.

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