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What's Next for Microsoft?

NEW YORK (TheStreet) -- Microsoft (MSFT - Get Report) had a lot going for it, prior to Satya Nadella becoming CEO. Now, the field has changed and it looks like Microsoft's fun in the sun may be over for the time being.

Deutsche Bank analyst Karl Keirstead downgraded shares to "hold," keeping his $42 price target, as many of the catalysts the Redmond, Wash.-based Microsoft had going for it have now played out. Included in those were Nadella replacing Ballmer, which happened in early February. The analyst also noted that positive sentiment has dwindled from other factors, including "big Xbox One print, a stabilizing PC market with better-than-expected business PC sales, share gains in enterprise software and our belief that Street sentiment towards the mega-cap incumbents (MSFT & ORCL) was too negative relative to the high-growth disruptors."

In Microsoft's fiscal second quarter, the company noted it sold 3.9 million Xbox One consoles, alleviating some fears that the company's next-generation gaming console was not performing as well as anticipated. A recent report from research firm Gartner notes that the PC industry, while still contracting, is not as bad as had been imagined, with HP (HPQ), a leading Windows original equipment manufacturer (OEM), showing strength.

Additionally, Microsoft's commercial Offices and Windows segment saw 10% growth last quarter, rising to $12.67 billion, as Office 365 commercial seats and Azure customers both grew triple-digits. That said, Keistead worries that momentum could slow down, now that Windows XP is officially retired, and most businesses have finally upgraded from the outdated operating system.

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Shares of Microsoft were lower in pre-market trading, off 0.43% to $39.04.

Microsoft recently announced plans to bring Office to Apple's (AAPL) iPad, continuing its push with enterprise software. "In enterprise software, we like the positioning of MSFT's cheaper product suite, but we wonder if MSFT's internal push to raise its software maintenance attach rate and to bundle more products into multi-year ELA-like deals has played-out to the point that the gap between MSFT's Server product growth (9%-12%) and its peers (more like zero-5%) could begin to narrow," Keirstead wrote in the note. The analyst stated that Microsoft's free cash flow is down 18% over the past six months, compared to a 7% growth rate for Oracle (ORCL).

Following the announcement of Office for iPad, Nadella tweeted that the Microsoft apps, Excel, Word and PowerPoint, were the top three free apps available for iPad.

There's also concern about the pending Nokia deal, which should close relatively soon. Keirstead highlights the issue that Microsoft's earnings estimates may come down once the deal is closed, given the company's weak position in handset sales. "MSFT guided to a neutral adjusted EPS impact from Nokia in FY15, but given weak Nokia handset unit sales, MSFT has its work cut out for it to hit this target," Keirstead noted.

Analysts surveyed by Thomson Reuters expect Microsoft to generate $89.9 billion in revenue, earning $2.90 a share.

Despite most of the positives being factored in already, there's still a lot to like about Microsoft under Nadella, as he focuses the company more on its cloud computing prospects, and keeping the company's exceptionally high gross margins in tact. "MSFT has also recently posted better-than-expected margin control that has offset much of the pressure from the mix shift to hardware and in our view the bull case for MSFT shares is increasingly rooted in a view that MSFT's CFO can continue to deliver," Keirstead wrote. "We also like the early stage mix shift to subscription-based and cloud-hosted services (Office 365, Exchange, Azure), even if the near-term impact on revenues is negative."

--Written by Chris Ciaccia in New York

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