Microsoft: My PC Crashed

NEW YORK (TheStreet) -- The technology barbell is the growing reality of companies being pulled in two directions, with the cloud on the high end and devices on the low end.

The center of the barbell -- the PCs and servers where Microsoft (MSFT) made its name and living for over three decades -- is being made virtually obsolete by all this. PCs crash, while clouds can be made as resilient as the Internet and devices can be replaced.

For the quarter ended in December, Microsoft reported revenue of $24.5 billion with $6.6 billion in net income, or 78 cents per share. The stock is at about $37, up almost one-third over the last year.

The device that really made this quarter for Microsoft is the XBox, its game console. The company sold 7.4 million combined units of the XBox 360 and XBox One during the quarter. The company also said it gained in tablets, but Surface sales came to just $893 million.

Microsoft also did better than expected on the business side of the barbell. Cloud revenue more than doubled, the company said, and its SQL Server gained market share.

All of this gives CEO Steve Ballmer's successor, due to be announced next month, a clear direction. Co-founder Bill Gates seems resigned to becoming the Microsoft version of the late Colonel Harland Sanders of Yum! Brands (YUM), or Charles Schwab (SCHW), a symbol in good times and a nudge in bad ones.

Microsoft needs to work both ends of the barbell. Devices are doing well right now, at some cost in margins. Windows is doing a slow fade, with original equipment manufacturer revenue down 3% for the quarter. Office can still be milked for more profits through the cloud. Things aren't nearly as dire as they are at IBM (IBM).

But things aren't great, either. Microsoft managed a 9% gross profit margin on its hardware, which is wonderful if you're a car company, but terrible next to the 83% margins it is accustomed to earning on commercial software.

In the past, Microsoft could be relied upon for fat profits from its Windows operating system and Office suite. Those days are ending, with Windows XP due to sunset this year, and with Office no longer being sold on disks, but as empty boxes with download keys.

This may be why, of 36 analysts who currently following the stock, 21 have it rated as just a hold against 12 who call it buy or overweight, with one calling it an outright sell.

That's because, as a hardware company, Microsoft has margins that will remain thin. Despite the company's best efforts, phone sales were still down, although since the merger with Nokia (NOK) is not yet complete, phone sales are not fully reflected in results. Microsoft has been selling the idea that all of a user's products work in the same way -- phone, tablet, PC and cloud -- and so one leg of that table needs to be propped up badly.

Worse, in smartphones, Microsoft is running third, behind both Apple (AAPL) and Google (GOOG). Google is selling unlocked Moto G phones for under $200 at its Google Play site (I recently got one), and so the margin pressure is certain to remain there.

But Microsoft is already sacrificing margin in devices in order to grow market share. Analysts love to say Apple margins are "hurting," but they're close to four times greater than Microsoft's. Devices are a winner-take-all market in terms of margin -- you either lead or you suffer. Except in gaming, where Microsoft and Sony (SNE) are crushing Nintendo (OTC:NTDOY) between them. Even so, Microsoft is suffering.

The barbell problem also reflects Microsoft's dilemma in choosing a successor to Ballmer, a decision that is as overdue as the choice of the Cleveland Browns' next coach. Among the leading candidates, Satya Nadella comes from the cloud side of the business, Nokia boss Stephen Elop from the device side, and there seems to be no candidate who knows both.

They may have offensive and defensive coordinators in place, but do they have a head coach with vision? Signs right now point to no.

At the time of publication the author owned shares in AAPL, SCHW and GOOG, but none of the other stocks mentioned.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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