RealMoney Silver - To Juice Growth, Microsoft Needs to Go Shopping

To Juice Growth, Microsoft Needs to Go Shopping
By Sramana Mitra
RealMoney.com Contributor
7/30/2007 6:56 AM EDT

For a change, Microsoft (MSFT) recently announced a great quarter. Even though the company took a charge of 8 cents a share to extend warranties on the Xbox 360, its net income still rose 7.3% in the latest quarter. Meanwhile, quarterly sales of Microsoft's Office 2007 suite of programs increased 20% vs. the year-ago period and contributed $600 million to revenue.

By all accounts, Microsoft is struggling in its consumer businesses and doing just fine in product lines that leverage its core strength of selling to business. This raises the question of whether Microsoft should continue its rather haphazard and, thus far, unsuccessful attempts at trying to be a leader in both Enterprise 3.0 and Web 3.0.

To answer that question, we need to go back to basic principles. Yes, Microsoft needs to be in growth markets, which, at the moment, are:

Web 3.0: I believe it will organize the Web into verticals and serve consumers in context.

Enterprise 3.0: It is a combination of on-demand, software-as-a-service (SaaS), extended enterprise applications and infrastructure.

Online Advertising: Everyone is trying to get a share of this market, which Google (GOOG) dominates.

Small Medium Enterprise (SME): This growth market has been notoriously difficult to penetrate, yet companies (including Microsoft, to an extent) are penetrating now, with the large-scale adoption of the Internet and telesales.

In a previous column, I outlined my turnaround strategy for Yahoo! (YHOO) on a Web 3.0 roll-up. But I absolutely do not recommend that Microsoft attempt a similar consolidation of many inherently consumer plays in various verticals like travel, real estate, jobs, etc. In fact, investing in Web 3.0 plays like CareerBuilder, as Microsoft has already done, is a much better way to play in these markets.

However, I do believe Microsoft, given its strength in business software, should consider the Enterprise 3.0 rollup of companies such as Omniture (OMTR) , Taleo (TLEO) , Concur (CNQR) and Qualys. In particular, Qualys would add a very interesting Enterprise 3.0 security offering to Microsoft's arsenal, as security is already one of Microsoft's stated areas of focus.

In an apparent panic, Microsoft just spent $6 billion to buy interactive ad agency aQuantive (AQNT) . To put things in perspective, online advertising is expected to reach $81 billion by 2011, representing a 21% compound annual growth rate, or CAGR, from 2006 to 2011. More specifically, U.S. online advertising is projected to reach about $25 billion in 2007, growing almost 20% to nearly $30 billion in 2008. Online brand advertising growth, at a 20% CAGR from 2006 to 2010, will exceed online search advertising growth over the same period.

These staggering market size and CAGR numbers explain why Microsoft tried to buy DoubleClick and, upon failing to do so, went for aQuantive. Both DoubleClick and aQuantive are more brand-advertising-focused solutions, and Microsoft, albeit reluctantly, has conceded the search advertising battle to Google.

If Microsoft wants to consolidate its position in this area, one option would be to roll up other interactive ad agencies. Under this thesis, AKQA, a privately held company, could be a potential acquisition candidate.

In the SME space, I have long believed that Microsoft ought to buy Autodesk (ADSK) . To be fair, Microsoft failed to buy Intuit (INTU) and got somewhat discouraged, so it then centered its efforts on Great Plains.

Today, Autodesk is a $10.25 billion company, with a large concentration of SME customers. It's expensive, but a strong, high-growth company with an incredibly sticky product line. It is also well-positioned to continue its growth over time.

Because Microsoft is breaking into the habit of writing multibillion-dollar checks, I'd like to see it go after Autodesk. In contrast to Aquantive, for which it paid $6 billion on revenue of $440 million, Autodesk has almost a $2 billion revenue line and a valuation of $10.25 billion. That seems like a much better value for the money.

So, what does Microsoft want to do next?

Presumably, it isn't ready to abandon the Xbox initiative or MSN. But, as the current quarter amply demonstrates, the company's real strength is in business applications. Getting distracted from that core and pursuing things about which it has no visceral understanding may be dangerous, as Google has also shown ambitions of going after Microsoft's core Office franchise.

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