Web work will help Microsoft narrow Google gap

By Daisuke Wakabayashi

SEATTLE - Microsoft has showed early signs of narrowing the gap with Google in its Web business, leading Wall Street to ask whether the world's biggest software company may be able to turn an overlooked unit into a financial powerhouse.

Microsoft's top executives plan to update investors about every facet of the $50 billion ($NZ62.3 billion) software maker's business, from its bread-and-butter Windows and Office franchises to its Xbox game console unit, at its annual analyst meeting.

But the company's smallest business division - online services - may garner the most attention, because it poses both the greatest opportunity for growth and the biggest risk of failure.

After investing billions to build data centers and pay for acquisitions, Microsoft wants to convince investors its loss- making online services will eventually become an engine of growth alongside desktop software, which accounts for almost all of its profits.

"If there is an Achilles heel, you have to say it's there," said Charles Di Bona, an analyst at Bernstein Research. "It will be an important bellwether, but it's a ways off before the segment has an impact on the top line or the bottom line."

The online services group, led by former Ask.com Chief Executive Steve Berkowitz, is showing signs of progress.

Microsoft posted a third straight quarter of revenue growth after sales in the four previous quarters fell. The company forecast the division's revenue would grow as much as 13 per cent in fiscal 2008, with online advertising sales increasing by more than 20 per cent.

These estimates do not factor in the impact of Microsoft's $6 billion acquisition of Web advertising company aQuantive Inc Microsoft's US Web search market share rose nearly 3 percentage points to 13.2 per cent in June after months of languishing around 10 per cent, according to research firm comScore Inc.

Those share gains, coming at the expense of Google and Yahoo, were driven largely by a marketing campaign to encourage people to use Microsoft's Live Search for everyday searches. It remains to be seen whether those gains can be maintained in July.

Catching up to Google, which is estimated to have captured nearly one-third of the world's online advertising market, remains a difficult and crucial task.

The Web search leader is growing four times as fast as Microsoft and it is introducing new software services such as online word processing and spreadsheets that strike at the heart of Microsoft's software dominance on the desktop.

Billion-dollar option

Many analysts are interested in Microsoft's online business, specifically because it has been overlooked.

"The stock price right now, the valuation, gives Microsoft no credit for its online initiatives," said Morningstar analyst Toan Tran. "If you buy the stock right now, you get a free option for the billions of dollars Microsoft is spending."

Microsoft shares are trading at 18 times estimated fiscal 2008 earnings, broadly in line with the S&P 500. The shares of the company's web rivals, Google and Yahoo, are valued at 26 and 46 times next year's estimated earnings.

Microsoft shares fell 39 cents to close at $30.80 in Nasdaq trading. The stock is up 5 per cent in the last two weeks.

Another area of focus at the analyst meeting will be Microsoft's estimate for Windows sales for this fiscal year.

Microsoft, which earns more than 75 cents in operating profit for every dollar of Windows sales, said segment revenue in its fiscal fourth quarter came in slightly below the company's 14 per cent estimates. It also forecast sales would grow between 9 per cent and 10 per cent this year.

Analyst said that forecast for Vista sales seemed conservative since Microsoft said at the introduction of Windows Vista in January that users will upgrade to the new operating system faster than its predecessor Windows XP.

"It's almost as if investors are treating the Vista cycle as the last hurrah," said Bernstein's Di Bona.

"In order to get really enthusiastic about the stock, which I am frankly, you have to believe that, not only is Vista a big deal, Vista is not the last big deal."


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