Since the launch of the iPhone in 2007, Apple (NASDAQ:AAPL) stock is up a stunning 376%. Microsoft (NASDAQ:MSFT) shares, on the other hand, are essentially unchanged.
But the company is fighting back with the launch of its own tablet, called the Surface. So far, investors are enthusiastic — the stock is up almost 4% in today’s trading.
So, is this the start of a long-term move for the stock? Or is it temporary? To decide, let’s take a look at the pros and cons:
Pros
Franchise Products. Microsoft has several major product lines that are likely to continue to generate substantial cash flows. The Office Suite has seemingly become a permanent feature of corporations across the world. While it has competition — including offerings from Google (NASDAQ:GOOG) — rivals probably will not be able to replicate Microsoft’s entrenched ecosystem.
The giant also has a strong business in back-end software, such as with SQL Server, Azure and Windows Server.
The Surface. The product will be critical to Microsoft’s success as tablets continue to eat into the market share of PCs. So far, the Surface looks impressive, especially for corporate customers. The device has a detachable keyboard and will include a modified version of Windows. If the Surface turns out to be quick and able to use robust versions of Office, the device is likely to win lots of uptake by customers.
Valuation. The stock is fairly cheap, coming to about 11 times earnings. There’s also a decent dividend yield of 2.7%.
Cons
Cloud. A big part of Microsoft’s software delivery is based on a traditional model — that is, the software is installed on computers. The company’s revenue model also involves upfront license payments and ongoing maintenance fees.
The cloud is much different. Software is delivered via the Internet, which makes it easier to modify and leverage data. This approach also tends to be cheaper, especially since revenues are often charged on a subscription basis.
Over the next few years, Microsoft will need to transition its business to the cloud — and it will be painful. The shift will require increased investments in data centers and applications development.
Acquisitions will also likely be critical — and the price tags will not be cheap. Microsoft recently purchased cloud-based Yammer for $1.4 billion even though Yammer’s revenues were minimal.
Internet Strategy. This has been a disaster. Microsoft’s search engine, Bing, has done little to unseat Google (NASDAQ:GOOG). According to CNNMoney, Microsoft has been losing $1 billion per quarter.
Bing isn’t the only problem, either. Just about every part of Microsoft’s consumer Internet assets have been underperforming.
Mature Markets. Microsoft’s core markets — Office and Windows — have reached saturation points. To find growth, then, the company will need to attack new mega opportunities, which will not be easy.
Verdict
The Surface will be the key to the performance of Microsoft. If it proves to be a useful device, it could be a driver for growth. IDC predicts that global shipments of all tablets are expected soar from 142.8 million in 2013 to 222.1 million in 2016. That’s enough to move the needle for Microsoft.
Besides, the company is currently selling at a fairly attractive valuation and has the support of cash cows such as Office and Windows. So in light of all these factors, the pros outweigh the cons for MSFT.
Tom Taulli runs the InvestorPlace blog IPO Playbook, a site dedicated to the hottest news and rumors about initial public offerings. He also is the author of “The Complete M&A Handbook”, “All About Short Selling” and “All About Commodities.” Follow him on Twitter at @ttaulli or reach him via email. As of this writing, he did not own a position in any of the aforementioned securities.
