Goldman to Microsoft: Here's What Needs to Change
When Goldman Sachs (GS) delivered its one-two punch to Microsoft (MSFT) on Oct. 3, downgrading its recommendation to neutral from buy and lowering its earnings estimates by 3% to 4% over the next three years, Microsoft's stock quickly felt the pain. The shares fell on Oct. 4 by 47 cents, or nearly 2%, closing at $23.91. Why the change of heart from Goldman -- and what can Microsoft do to get the influential firm -- and investors -- to reconsider?
Microsoft's tablet cupboard is bare, and Corporate America is taking its sweet time in upgrading its Windows-based computers. Those are the two near-term factors that prompted Goldman Sachs analyst Sarah Friar to drop her enthusiasm for the stock.
As she pointed out in her research note: "We believe the intrinsic value of shares cannot be unlocked if the status quo remains, and we have increased caution near term on a more elongated PC refresh cycle, combined with the newer threat of notebook cannibalization from tablets, where Windows does not yet have a presence." She further noted: "Concerns over the longer-term sustainability of the Windows/Office franchise have clearly weighed on the stock."
Greater Focus Needed
Regarding a remedy for what ails Microsoft, Friar has her own three-point plan. It includes jacking up the dividend to shareholders beyond the recent 23% increase, designing a coherent consumer strategy and exhibiting leadership when it comes to cloud computing.
If Microsoft is able to come through on these three points, Friar says she'd consider reversing her 12-month stock price target, which she lowered to $28 a share from $32, as part of her revised outlook.
According to Friar's research note, Microsoft's consumer strategy suffers from the proverbial shotgun approach and instead needs greater focus. Particularly, Friar is hoping the software giant will devise a "credible" response to the threat from tablet computers and smartphones that threaten to erode its prized and profitable Windows business.
Microsoft will have a chance to show if it can respond to that threat next week during its launch of Windows Phone 7, which it designed to do battle with Apple's (AAPL) iOS 4 and Google's (GOOG) rapidly advancing Android mobile operating systems. But getting the mobile market on its side won't be easy, considering Microsoft's troubled track record in delivering user-friendly and endearing mobile operating systems.
Several Signs to Watch
In addressing the Oct. 11 Windows Phone 7 launch, Friar said: "The initial release of the [Windows Phone 7] phone will be through AT&T in the U.S., iPhone's exclusive carrier, making the launch more difficult out the gate. The Windows Phone 7 Series does mark a departure from Microsoft's mobile OS predecessors, but for Microsoft to gain credibility in mobile, we believe the company will need to see immediate success."
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Investors can gauge Microsoft's results by watching several signs: mobile traffic data, developers clamoring to develop third-party applications for Windows Phone 7 and holiday sales of mobile handsets loaded with Windows Phone 7.
On the tablet computer front, Microsoft CEO Steve Ballmer said over the summer that Windows 7 tablets are on the way, and plenty of them should be showing up before year-end. To date, however, not one manufacturer has released a tablet computer running Windows.
With the critical holiday season fast approaching, Microsoft can bet investors are keeping a close eye on the calendar. Oct. 11 will provide the first glimpse of how those holiday sales might turn out.
