Microsoft ( MSFT) will have a hard time grabbing as many headlines in 2005 as it did in 2004, especially in the wake of its blockbuster $32 billion special dividend announced this past summer. Indeed, the software titan already has cautioned investors that tougher comparisons loom this year, in part because the dividend payout reduced investment income but also because no major new releases of Microsoft's flagship Office and Windows franchises are slated for 2005. Instead, Redmond, Wash.-based Microsoft has suggested that investors stay tuned until 2006, when the next versions of both products are launched. That pitch is sitting just fine with some Microsoft shareholders, who have enjoyed a 10% return on their stock in 2004, compared with a modest 2% for the Goldman Sachs Technology Index. "A lot of stuff going into calendar 2006 keeps the story very interesting," said Rich Parower, portfolio manager of the ( SHGTX) Seligman Global Technology Fund . But that's not to say there aren't a few milestones to watch for in 2005 that could boost Microsoft shares, analysts and investors say. Among them: A beta version of the new Windows operating system, dubbed Longhorn, in the first half of the year. The next generation of its Xbox video-game console by Christmas. The new version of Microsoft's SQL database, delayed from 2004, and its developer tools, both expected by late summer. The first milestone, the Longhorn beta, won't actually generate any new revenue -- that will come when the final version is launched in 2006 -- but it will offer a good idea of the final version and how much its new features will ultimately drive sales. Such detail could be enough to move the stock one way or another, investors said. "It's important that they get it out on time ... which will be encouraging to investors," said Tony Ursillo, an analyst with Loomis Sayles & Co., which holds Microsoft shares.
Goldman Sachs analyst Rick Sherlund echoed that sentiment, noting that a beta of Microsoft's flagship Office suite also should coincide with the Longhorn beta release. "The launch of these two products (Longhorn and Office 12) should significantly accelerate MSFT's growth rate, and we would expect the stock to begin to anticipate this benefit as these products are released to beta test by next summer," Sherlund wrote earlier this month. (Sherlund has an outperform rating on Microsoft and his firm has done banking with the company.) Still, Sherlund acknowledged, "investors likely have a two-year valley to look past until the twin engines
Longhorn and Office 12 actually rev up." As a result, PC sales will be an important growth driver for Microsoft until then, he said. One component of PC growth could be sales of Media Center PCs, personal computers that incorporate Microsoft's relatively new media-focused operating system, said Matt Rosoff, an analyst with Directions on Microsoft, an independent research firm that tracks Microsoft. Sales of Media Center PCs, which are slightly more expensive than standard Windows, are one gauge of Microsoft's strategy selling into the home, the primary market for the entertainment-focused computer, Rosoff said. Still, hardware makers shipped a mere total 189,031 Media Center PCs worldwide during the third quarter -- a tiny fraction of the overall 44 million computer shipments during that period, according to market research firm IDC. Given those small numbers, investors are likely to shower far more attention this year on another piece of Microsoft's home entertainment strategy: its next-generation Xbox video-game console. With an expected pre-holiday debut, the new Xbox wouldn't drive sales until Microsoft's fiscal 2006, which begins in July. But that launch is expected to be at least a good one to two quarters ahead of rival Sony's ( SNE) new PlayStation console, which could be a crucial difference from the current console race, when Sony beat Microsoft to market.
"They're not going to be trailing Sony timing-wise," said Merrill Lynch analyst Jason Maynard, who has a buy rating on Microsoft. "I think it's a huge advantage." (Microsoft is a non-investment-banking customer of Merrill.) It will be important for Microsoft to take advantage of that lead time to knock out competitor Nintendo and turn the competition into a two-console race, Rosoff said. Investors, meanwhile, are hoping that Microsoft's experience from its first foray into the video-game market and beating Sony in the next console cycle will mean it loses less money making Xbox and even brings a profit to its Home and Entertainment division, which also includes video-game sales. Microsoft is rumored to be dropping the hard drive from its second-generation console, which would lower manufacturing costs, analysts say. Another possibility, Rosoff said, is that Microsoft will offer two versions of Xbox -- one with a hard drive and one without. In the current console race, Sony has captured significantly more of the U.S. market -- 58% for PlayStation 2 vs. 24% for Xbox, according to NPD Group and Sony. That's not only because Sony hit the market first, but also because more games are for sale on PlayStation 2 than Xbox. With Microsoft now a more experienced player, the content advantage could slip, investors say. "They
Microsoft have established themselves well enough that they can get either some exclusive content beyond the Microsoft titles or dual commitments from publishers who were going exclusive on the PS2 before," Ursillo said. "I don't think you'll see many publishers willing to forgo a sizable Xbox share just to be on the PlayStation 3." A less sexy offering than video games, but still an important one, will be Microsoft's launch of a new version of its SQL Server database, dubbed Yukon, and Visual Studio.Net developer tools, code-named Whidbey, by next summer. Developers use the tools to build third-party applications on top of Microsoft's Windows .Net platform.
"Both of those together are really a continuation of Microsoft's
.Net development platform and could boost growth in the Server and Tools business segment," Rosoff said. He expects the bulk of Microsoft's near-term growth to come from that Server and Tools segment, which includes not only the database and developer tools but also Microsoft Windows server software. The Server and Tools segment posted an impressive 18.9% jump in sales in the September-ending quarter. Ursillo estimates SQL sales still only account for a small percentage of Microsoft's overall revenue -- somewhere in the low-single-digit percentages -- but "it's growing faster than the overall company." At the same time, rival Oracle ( ORCL) is attracting attention with its competing database's focus on grid computing and the Linux platform, Ursillo added. That puts more pressure on Microsoft to introduce "something fresh," he said. Sherlund also highlighted the potential significance of the new database and developer tools. "These products will not drive big revenues compared to the twin engines of Windows and Office, but may help a bit in bridging the gap until the new Windows and Office are released," he wrote. And such a bridge may just be enough to satisfy Microsoft investors until Microsoft revs up again in 2006.