Nadella's Microsoft Even Cloudier Than Ballmer's

NEW YORK (TheStreet) -- Satya Nadella has barely warmed the seat as Microsoft (MSFT) CEO and he is being bombarded with advice, speculation and claims of a "new direction" for the company.

But just how broken is Microsoft?

In its most recent fiscal year, Microsoft had almost $78 billion in sales with net income of $21.8 billion. For the first six months of the current fiscal year, it has reported sales of about $43 billion with net income of $11.8 billion. In terms of sales and net income, Microsoft remains bigger than Google (GOOG).

Despite all the media reporting on how badly run the company was under former CEO Steve Ballmer, Microsoft remains hugely profitable, with its Windows operating system and Office suite at the heart of that profitability. A certain amount of continuity is expected, and choosing an insider as CEO is not an indication, by itself, of a major change in direction.

But hedge fund investors are demanding major change. They want to unlock the value of product successes such as the Xbox, possibly through a spinoff, and dump losers like Windows Phone and the Microsoft Surface, both of which are losing money. The price-to-earnings ratio for Microsoft is currently at a market-lagging 13.3, similar to Apple's (AAPL) 12.6, while Google has an eye-popping P/E of 31.5.


WATCH: Jim Cramer to Microsoft's New CEO Satya Nadella: BUY BUY BUY

Bringing excitement to Microsoft could cause investors to value its earnings more highly, raising the stock price and giving the hedge funds that have invested in it a quick profit. They want Nadella to indicate a new direction that will create that excitement.

The question is not only whether Nadella has a firm direction in mind for the company, but whether he can get investors to buy into whatever transformation he chooses to make, and sell it to a skeptical computing world.

Much of what is expected from Nadella centers on cloud. I have written that Nadella needs to convince his board to invest much more heavily in cloud infrastructure now, when the market is valuing it highly, or lose ground permanently to its rivals.

Before taking the top job, Nadella ran Microsoft's Azure cloud service, which has been badly lagging Amazon.com's (AMZN) Amazon Web Services despite recent efforts to match Amazon's features and pricing.

Amazon offers pure cloud infrastructure. When tools for writing and running software are added to a cloud, it becomes a cloud platform, and that is how Azure was originally sold, as a platform. The idea was that by supporting Microsoft tools, Azure offered a smooth transition to cloud for Windows customers.

The ultimate goal of cloud, however, is to provide a service, and it's to Software as a Service, through companies called Managed Service Providers, that Nadella is now expected to move. 

This resembles Microsoft's old strategy of luring developers to write programs under Windows. The question being asked is whether Windows will remain the focus. Hedge fund investors see a need for Microsoft to better serve devices such as the Google Chromebook and Apple iPad, and an overt identification with Windows hurts that effort.

Nadella's appointment is being treated as a very big deal in his native India, where reporters are oozing over his love of cricket and bragging about his pay package -- $1.2 million base salary with stock incentives that could reach $18 million.

Microsoft can take advantage of that by bringing large Indian outsourcing companies such as Infosys (INFY), Wipro (WIT) and Tata into a closer orbit. These companies have a combined turnover of $100 billion and are benefiting from a weak rupee in international markets.

The Nadella announcement eclipsed word of an alliance between Microsoft's Bing search engine and Foursquare, a market-lagging social recommendation service. Microsoft is putting $15 million into Foursquare as part of its effort, which aims at local search, but the commitment to Bing will remain uncertain until Nadella speaks to it.

And this is the ultimate question, where the balance will be between investment in business software and consumer products. Microsoft is a highly successful business software company, and the perception is it is failing in its consumer-oriented endeavors. It's not just a question of where Nadella will invest, but what Nadella will drop in order to do it.

At the time of publication the author held shares of GOOG, AMZN and AAPL.

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

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