Microsoft’s higher than expected costs this year aren’t just related to the war with Google, according to a note Goldman Sachs analyst Rick Sherlund sent to clients this morning.
Sherlund speculated that Microsoft’s earnings are also taking hits from Vista and the “rapid growth” of the “booming” Xbox business.
That said, there “may be a benefit to the stock as investors focus on the growth opportunity in the
software as a service/ad based business model.”
Vista isn’t likely to be broadly available until the end of March or early April, he said. The confusion about Microsoft’s earnings clears up a bit when you substitute high-margin Windows sales for low-margin Xbox sales in the upcoming quarters.
“We had previously assumed a delay until March for the launch of Vista versus the announced January date (which had earlier slipped from October),” he wrote. “We have now backed out one month further until the end of March or early April, effectively backing out all of the remaining Vista revenues from the March 2007 quarter.”
The good news? The suspense will end someday. “At this point, we believe a Vista delay is widely expected, so getting this out of the way might actually be a positive,” he wrote.
Sherlund also predicted that Xbox 360 will trounce Sony’s PlayStation 3 in the current console cycle lasting five to six years. The Xbox business will be profitable by 2008 and start improving Microsoft’s overall margins in 2009.
That’s a mixed bag. Xbox “may be a much bigger part of the damper on earnings in fiscal 2007 than was realized on the April call given the increased mix of this currently unprofitable business. Second, investors have questioned whether the success of Xbox would hurt margins at Microsoft. The answer seems to be yes, but with most of the impact in fiscal 2007 and 2008. The impact should diminish later in the cycle as the cost structure improves and the highly profitable games business ramps up, leading to improving margins.”
For Microsoft’s upcoming 2007 fiscal year, Sherlund lowered his total earnings per share estimate by one cent, to $1.41. He lowered his third quarter 2007 estimate by a nickel per share, but adjusted other quarters up by a few cents each.