Microsoft's Urge for Emerging Business

You'd expect Microsoft(MSFT) to keep a spotlight on its big moneymakers Windows, Office and Servers -- after all, they do generate more than 80% of the company's sales.

But the software giant also is busy readying its so-called emerging-business units for their close-up. For two of the four, MSN and Home and Entertainment, which represent 15% of the company's trailing 12-month sales, the future is nigh, say analysts.

Microsoft is pumping substantial sums and energy into those often-neglected units, hoping the investment will drive future growth.

In a November research note, Pacific Crest Securities analyst Brendan Barnicle put a number on just how much Microsoft's emerging businesses could matter in coming years. He projected that they could flip-flop from being a drain of 5 cents a share on Microsoft's earnings to boosting earnings 13 cents a share by fiscal 2008. (Barnicle or a member of his family holds Microsoft shares.)

The analyst believes that the biggest opportunity for upside is in Microsoft's MSN Internet division, which first operated in the black in fiscal 2004. He suggested that online advertising will help MSN sales grow 14% in fiscal 2007 and achieve a 40% operating margin.

Microsoft has been trying to more aggressively compete against the search businesses of both Yahoo!(YHOO) and Google(GOOG), and some investors have taken notice.

Loomis Sayles & Co. analyst Tony Ursillo noted at a recent demonstration how Microsoft's Encarta encyclopedia answers users' questions instead of merely providing a list of Web sites that could offer such answers.

"The business is clearly a huge profit generator, and I think Microsoft has some unique intellectual property that it can bring to the game," Ursillo said of MSN search. (His firm holds Microsoft shares.)

High Hopes for Xbox

Still, Ursillo and others feel the company's Home and Entertainment division represents Microsoft's most important emerging unit.

Indeed, Merrill Lynch analyst Jason Maynard said the division represented the software titan's "biggest potential for a home run." Earlier this year, Maynard projected that the division could be profitable in fiscal 2006 or 2007 -- conceivably earlier than Microsoft has predicted. (Maynard has a buy rating on Microsoft, and his firm has done non-investment-banking business for Microsoft.)

The biggest portion of sales in the division come from Microsoft's Xbox video-game console. Microsoft is expected to launch the next version before the 2006 holiday season -- crucial timing, because it's expected to come ahead of rival Sony's(SNE) new PlayStation.

Looking Past Windows Microsoft is priming four of its smaller divisions for profit
Segment	2004 Sales (millions)	Year-over-Year Sales Growth	2004 Operating Income/(Loss)(millions)	Fiscal year projected to be profitable
Home and Entertainment	$2,876	4.7%	$(1,215)	2007
MSN	2,216	13.5	121	2004
Microsoft Business Solutions	667	17.6	(255)	2006
Mobile and Embedded Devices	247	58.3	(224)	2006
Source: Microsoft