Microsoft Must Show Might

After talking down Vista bulls, any indication of weakness will be taken as a dire sign for the company.
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No surprises.

That, in a nutshell, is what the Street is expecting from

Microsoft's

(MSFT) - Get Report

third-quarter earnings report Thursday afternoon.

Analysts are expecting a solid, if not stellar, quarter from the software giant. The 34 research desks polled by Thomson Financial are looking for the company to report 46 cents a share, smack dab inside a tight range of 45 cents on the low side and 47 cents on the high. Now that's what I call consensus.

The forecasts for revenue comprise a slightly looser range: $13.7 billion on the low end and $14.1 billion on the high. Hitting the middle ground of $13.9 billion would spell out a 27% growth rate, driven largely by sales of Microsoft's core product, Vista operating software.

The trouble with surprises is that they tend to strike when you're least expecting them. And while only Microsoft's financial team knows for sure what the actual numbers will be, there are the usual pre-earnings whispers out there that Microsoft will surprise to the upside.

Back in the day, Microsoft was a master at the delicate art of beat-and-raise -- surpassing the Street's forecasts by a substantial margin and raising guidance for the coming quarter. For a while, though, it had lost its magic touch, reporting in-line or even disappointing earnings numbers.

But in the past two quarters, Microsoft seems to have gotten its financial finesse back. In its first fiscal quarter ended Sept. 30, 2006, earnings of 35 cents a share were 13% ahead of the Street. Last quarter, its 26-cent-a-share earnings were 10% stronger. In both cases, its stock rallied on the numbers.

Microsoft's stock closed up 0.7% to $28.99 Wednesday, having slowly but steadily inched its way up from its low this year of $26.60, which it hit in early March.

Even with those gains, Microsoft's stock is down nearly 8% from its high of $31.39 on Jan. 12, after having finished a seven-month, 46% rally powered by hopes for strong sales of Vista as well as other products such as Office 2007, Xbox 360 and server software.

For some of that retreat in stock performance, Microsoft has no one to blame for itself. In February, Microsoft warned analysts not to get too excited about how much Vista would boost overall revenue in its fiscal year beginning July 1, suggesting they should dial back on their profit forecasts for that year.

More broadly, this gradual seesawing of Microsoft's stock price in the last quarter is caused by a protracted, slow-motion round of tug-of-war between those excited about a strong third quarter and others concerned about longer-term prospects for the company.

Those concerns were summarized by Goldman Sachs analyst Sarah Friar, who this month picked up coverage of Microsoft and promptly crossed it off its "America's Conviction List," which is not, as you might reasonably guess, a list of U.S. companies convicted of crimes, but a list of select buy recommendations. Goldman has performed investment banking services for Microsoft.

Friar, who has a buy rating on Microsoft, said too many trends -- software as a service, virtual computing, open-source software -- are ushering in a new era in which Microsoft's operating system becomes less and less essential. Elvis, in other words, has left the desktop.

Such concerns are underscored by the sight of

Google

(GOOG) - Get Report

eating Microsoft's lunch month after month. Following several high-profile defections of Microsoft stars to the Googleplex, Google has snapped up some notable acquisitions, like DoubleClick, which have made Microsoft's $29 million in cash and short-term investments look impotent.

So far, Google's moves against Microsoft have posed a narrow threat to the company: Microsoft has for years been fighting an uphill battle in online media without gaining ground. Google CEO Eric Schmidt has said he sees Google Apps -- Web-based rivals to Microsoft's desktop-bound Office suite -- as the next likely revenue stream.

All of that explains why Wall Street will be watching most closely the formal guidance that Microsoft gives Thursday. Having already discouraged analysts from getting too excited about fiscal 2008 earnings, any indication of weakness in its formal guidance will be taken as a dire sign indeed.

In other words, in the game of beat-and-raise, keep your eyes on the raise. If it's not there, that will be a surprise -- and not a pleasant one.