Microsoft's Future Licensing Business Expected to Benefit Significantly from Windows 10

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Jan 28, 2015

Microsoft (MSFT, Financial) reported its second-quarter 2015 earnings on Monday, January 26, shortly after its Windows 10 presentation on January 21. For the quarter, the company posted earnings per share of $0.71 from revenue of $26.47 billion and net income of $5.86 billion. The quarter’s earnings results were on target with estimates of $0.71 for earnings per share and revenue was slightly higher than analysts’ consensus of $26.33 billion.

Windows 10 should help Microsoft’s Devices and Consumer and Commercial Licensing businesses; however, the business impacts are not likely to occur until 2016. In the second quarter, Devices and Consumer Licensing revenue for Microsoft was down 25% from the comparable quarter and 18% for the year to date comparison. The ending of Windows XP support was a contributor to the lower revenue in the segment. Commercial Licensing fell only 2% on a comparable quarter basis and was even in the year to date comparison.

On January 21, Microsoft presented its new state of the art Windows 10 operating system in a Redmond, Washington presentation. The operating system will be available for use on personal computers, phones, tablets and the Xbox.

Its January 21 product presentation, primarily for developers, demonstrated the new operating system’s features and the ways in which it will help take users to a new productivity level. Key highlights for the new Windows 10 included digital assistant capabilities, a new web browser and user experience interchange capabilities across all devices. Microsoft also reported that Office would now be included on Windows 10 mobile devices. Microsoft also presented its newest device, the HoloLens. The HoloLens will be the most innovative holographic product in the technology market. Its sound sensors and processing capabilities will all work through Windows 10. The HoloLens will contribute to revenue on many levels for Microsoft.

For its commercial customers, Microsoft introduced Microsoft Surface Hub. The Surface Hub will make virtual meetings easier and more productive for Microsoft’s commercial clients.

Lastly, Microsoft also reported on its Xbox. Windows 10 will provide cross-platform capabilities so users can stream Xbox games from the Xbox console to Windows 10 on a PC or mobile device. Windows 10 will also have advanced gaming features, and users will be able to enjoy Xbox games on multiple devices.

Currently, Microsoft’s focus for Windows 10 is on the developer market. It is Microsoft’s goal to provide innovative universal applications with its Windows 10 operating system. This is Microsoft’s current focus and likely a factor affecting the price point for the software’s launch. Microsoft has been cautious in its initial approach to the Windows 10 launch focusing primarily on the developer market.

In its second quarter earnings conference call, Microsoft’s chief financial officer reported that the company would be providing more details on the product in a webcasting briefing on April 29 at its Build Developer Conference. According to media sources, the technical preview for Windows 10 will end on April 15 so the April 29 briefing is likely to provide more detailed revenue expectations on the product which is likely to be launched in June 2015. While customers can receive a free Windows 10 upgrade in the first year, its launch is still likely to be impactful in Microsoft’s first quarter 2016.

Overall, the Windows 10 operating system will help revive revenue in Microsoft’s Devices and Consumer and Commercial Licensing businesses. The launch of Windows 10 should more evenly balance its Consumer and Commercial Licensing businesses with its other business segments that showed strong growth in the second quarter. Specifically, in Devices and Consumer Other, which includes Office 365, Microsoft grew revenue 30% from the second quarter of 2014. Commercial Other also saw significant growth in the second quarter, up 46% from the comparable quarter on strong sales from Office 365, Azure, Enterprise Mobility Suite and Dynamic CRM Online.

In the second quarter earnings announcement, management reported third quarter revenue guidance of $20.6 billion to $21.4 billion, below analysts’ consensus of $23.78 billion and above third quarter 2014 revenue of $20.40 billion. Analysts estimate revenue of $98.17 billion for 2015 versus revenue of $86.83 billion in 2014.

In the day following the earnings announcement the stock was down 9.25% to $41.19. The stock’s value is likely to remain at its current level in the near term with minimal upside potential given the uncertainty in licensing and the lower guidance.