Microsoft Stock Plumps Up on PC Sales

SAN FRANCISCO -- While the successful launch of its Halo 3 video game has grabbed headlines, news of strong global third-quarter PC sales has raised expectations for Microsoft's ( MSFT) first-quarter earnings report late Thursday.

The stock has climbed to $31.25, a gain of about 10%, since Sept. 20, when it had spent more than a month languishing below $30. Initial sales reports on Halo helped push it past that threshold, and the stock rose even further last week after PC sales data came out.

Analysts expect Microsoft to post revenue of $12.57 billion, which would be 16% above last year's top line of $10.81 billion, according to Thomson Financial. The company is expected to earn 39 cents a share, excluding items.

"There should be upside because PC growth was much higher than expected," says Sanil Daptardar, equity analyst at Sentinel Investments, which held 1.2 million shares of Microsoft at the end of June.

"From a valuation and cash-flow perspective, the stock is a good buy," Daptardar says Tuesday.

"They are having overall a solid quarter," says Chuck Jones, senior vice president at Atlantic Trust Private Wealth Management, which holds Microsoft shares.

According to Gartner, third-quarter global PC shipments, a good indicator of operating system sales, grew 14.4%, although U.S. shipment growth was slower than expected, at 4.7%.

"Strong PC growth, depending on geographies, might balance out to high single- to low double-digit growth rates," Jones says. The Redmond, Wash.-based company's revenue growth should trend a little lower than that of the worldwide PC marketplace, he added.

The risks to Microsoft's earnings come from possible slower-than-expected uptake of its Vista operating system, which shipped in early 2007, "and PC growth being overseas, where there's piracy," Jones says. Also, there is risk that large licensing agreements failed to close.

But Microsoft is less vulnerable to an earnings disappointment in that regard than IBM ( IBM), he added. IBM said last week that it had failed to close key software deals over $1 million.

"More revenue is coming off deferred revenue from the balance sheet. So it would be a huge surprise if they were to come in short, given their conservative guidance," Jones said.

"We expect another strong quarter of double-digit growth, about 16%, to $12.58 billion," says Allan Krans, analyst at Technology Business Research, which does not hold shares or make a market in Microsoft.

"For the largest software company in the world, that's still very substantial growth," Krans says. "IBM, the second-largest software vendor, has not been able to sustain the double-digit growth that Microsoft has."

Krans says he also expects profitability to increase due to the strength in business client software, which has a margin of 70% to 80%.

Microsoft's second-quarter data showed a market preference for premium versions of Office software. This supports investors' bullishness. "I assume the uptake of premium products will be tending toward strong growth in the quarter," Daptardar says.

In the entertainment and devices division, Microsoft's game software and console lead the story. "One of the biggest impacts is how Xbox does in any quarter," says Krans. "It's been a large loss-leader for the company. The best case scenario for them is to close the loss gaps."

The Xbox is the second-best-selling console after Nintendo's Wii. But the Xbox 360, released in 2005, just displaced the Wii among the latest generation of hardware boxes.

Sales of game software and participation on the Xbox Live interactive gaming platform are becoming profitable for Microsoft as they pick up speed. "We expect the losses in the entertainment and devices division to taper off," as the customer base grows and sales of popular software such as Halo 3 expand, Krans says.

Halo 3 sold 3.2 million copies in its first 12 days following its Sept. 30 launch, helping to push sales of Xbox 360 consoles. However, the quarter's end will only reflect about five days of sales.

The online services segment is Microsoft's big question mark, but takes on even more significance with the company's announcement late Wednesday of an expanded ad partnership and equity stake in social networking site Facebook.

Investors also await further proof that the company can make full use of its new acquisition aQuantive, a diversified online advertising software and services company.

Krans is projecting 11% revenue growth in online services for the quarter, which is just a fraction of what's happening at Google ( GOOG).

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