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Microsoft's Clouds May Break If Vista Boots Up

Ivy Lessner

But Vista's effect on the software giant's stock may be worth the wait.

Vista replaced XP, whose Home and Pro editions had an estimated 538 million legal copies installed by the middle of 2006, according to IDC.

But it took XP four years on the market to account for half of all operating systems installed, according to data from Gartner.

Reflecting a softer adoption rate for Vista than expected, Microsoft recently "fine-tuned" the sales ratio of Vista to XP in setting revenue projections for 2008. Microsoft now expects 78% percent of its operating systems to be the higher-priced Vista, rather than 85% expected earlier in the year, according to CFO Chris Liddell.

While Vista revenue projections weren't disclosed, the change in the Vista/XP mix lowered the revenue to be recognized during the current quarter -- an undisclosed fraction of actual Vista sales -- to $540 million for the first quarter. That's $120 million less than Microsoft had previously expected, from a 7 percentage point shift in the mix.

But that downgrade in expectations isn't worrying observers who still see opportunity in future Vista uptake.

"We continue to see the most likely opportunities around Vista" from higher-volume enterprise licensing, a shift to premium SKUs (stock-keeping units) and gains on piracy recapture, wrote Bank of American analyst Kirk Materne in a recent research note. Microsoft is an investment banking client of BofA Securities.

"Each percentage point in incremental growth in the client business drives one cent in EPS," Kirk Materne, analyst with Bank of America Securities, wrote regarding Vista in a recent report issued Friday. "We continue to see room for 2 to 3 cents of EPS upside based on strength in the client business alone."

Michael Cherry, a senior analyst at consulting firm Directions on Microsoft, says Vista "is doing what I expected: It's selling at the run rate of PCs ... nor is there anything so wrong with it that it would have sold slower," Cherry said.

Microsoft Chief Operating Officer Kevin Turner said Vista has gotten traction in only 19% of the enterprise and mid-market space. The other 80% provides a "big opportunity" for 2008 sales.

The focus on Vista is no smaller after the company's financial analyst meeting last week, which touted the company's future plan regarding Web-based software delivery and online operations, without immediate certainties as to when those strategies would deliver.

Microsoft's Client division, which makes Windows, contributed more than 28% of overall revenue in Microsoft's recent fourth quarter.

Shares of Microsoft rose to above $30 late last year in anticipation of Vista's January 2007 launch, only to fall back below $28 after its release. The stock rebounded, but then fell amid the heavy selloff late last week. Trading recently at $29.63, the shares are essentially flat over the past three-and-a-half years.

Some businesses may be waiting for Microsoft to bring out its Service Pack 1 patch for Vista. The company says it expects to release the beta version before the end of the year, noting that service pack availability is less important since most updates are available online.

More important than the service pack, says the company, is the sales uplift from cross-selling the Microsoft Desktop Optimization Pack to businesses. The MDOP enables IT departments to control their desktops and remotely update systems.

"In mature markets, it's more about upselling premium editions and cross-selling," Turner said.

Within businesses, Vista seems to have gotten off to a slow start because many companies buy through original equipment manufacturers, rather than directly from Microsoft, possibly slowing the reporting of those sales, Cherry says.

And a corporate upgrade to Vista isn't quite like getting your hands on your first Apple(AAPL Quote) iPhone: "It goes into the queue of the work the IT group has to do," where it has to compete with the department's other priorities, Cherry says.

So far, Vista has been unable to displace XP Professional: The latter's share remained at 43.7% of the worldwide market -- the same as in 2006. Initially, Vista appears to have displaced Windows 2000 Professional and older editions, as well as XP Home.

"Over the next year, we'll start to see uptake" of Vista by corporations, Cherry says.

Turner said the company is reaping benefits from its investments in Vista's security features and stability. "Vista is the most secure operating system we've released," said Turner.

In the first 180 days, Vista experienced half the number of "high-severity vulnerabilities" found in the six months following XP's launch, Turner said. "Windows Vista's had far fewer [security vulnerabilities] than Apple or any major Linux distributor."

The increased reliability of the product has led to 21% fewer support calls per unit shipped than with XP, Turner said.

Still, Vista has taken it on the chin lately. Although consumers are opting for premium over basic versions of Vista, they've been critical of Microsoft for the lack of Vista software and driver support coming from designers of devices and software. And on July 23, Gianfranco Lanci, president of computer manufacturer Acer, was quoted by the Financial Times Deutschland as saying that the computer industry has been disappointed by Vista.

According to Turner, device and software makers are finally stepping up: Over 2,000 applications now work with Vista. "That's up from 650 at launch," he said. And 70 "critical applications" have been updated by partners to improve performance since the launch, he added.

Vista is now supported by over 2.1 million devices, compared to support for 1.5 million at launch. Turner said 98% of devices are Vista-ready, including 11,000 branded devices.

"That's a huge number of devices. But if there's one device you need, you don't care about the others," Cherry says, explaining the ongoing criticism by consumers.

Both Microsoft and software/device makers share the blame. By continuing to rewrite Vista's code up until launch, Microsoft unintentionally discouraged the market from developing drivers and support early, Cherry says.

And since the launch, some device manufacturers have been reluctant to spend money writing driver software for existing devices on which they earned little margin to begin with.

But many of those issues are being solved, according to Turner.

"When any new operating system is released, it takes time to work through the ecosystem issues," Turner said. "The progress we've made with partners to improve the customer experience is unprecedented."

"We came out around applications and devices in far better shape than we were with XP." But the number of devices and applications has proliferated tremendously since XP's launch, he added.