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Microsoft Looks Mighty

Shares hit a new 52-week high after a billion-dollar revenue surprise.

SAN FRANCISCO -- Now that Microsoft (MSFT) - Get Report has pulled a $1.2 billion rabbit out of its hat, the six-cent-a-share question is whether it can do it again, quarter after quarter.

Those are the numbers by which the Redmond, Wash., software company

beat the Street's third-quarter revenue and earnings estimates Thursday.

Or as UBS analyst Heather Bellini put it in a research note Friday: "What's a $1 billion-plus of revenue and 6 cents of EPS upside among friends?" Bellini raised her 12-month price target on the stock Friday to $40 from $37. Microsoft is an investment banking client of UBS.

The stock was recently up $3.01, or 9.4%, to $35, almost assuredly on its way to a new 52-week closing high.

The company acknowledged that strong third-quarter PC sales was a big contributor to sales of its operating systems and Office software, as was its well-timed launch of video game phenom

Halo 3

a few days before the end of the quarter. The company recorded $330 million in


revenue, little more than the sale of pre-ordered games, sidestepping a meltdown in next year's third-quarter comparisons.

With economic turmoil, PC sales could flag in coming quarters. But for a company where timing is everything, Microsoft is pacing itself with a refresh to its server line in early 2008 that the company expects to provide growth over the coming two years, when its Office software will have "tough comparisons" with 2007 figures, according to CFO Chris Liddell.

But don't count out continued upside from client software. Corporate IT departments have been sitting on the fence, waiting for either the distribution of Vista's Service Pack 1 -- its package of post-release patches and updates -- or just a good reason to commit entire companies to upgrades.

However, Microsoft has been reading the tea leaves and says tech managers are about to jump in.

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Looking at its unearned revenue balance for the quarter, Microsoft saw that client volume licensing -- or corporate sales of Windows and Office 2007 -- jumped 27%. "That is a very good leading indicator from our point of view" that businesses are starting to buy Vista, said Liddell.

Since Microsoft relented to customer demand and offered an upgraded Windows XP operating system, customers chose Vista 65% of the time over XP, according to Liddell. The company sold 85 million copies of Vista during the quarter, compared to 45 million for XP.

But the real good news on the client software side is what Microsoft calls its premium mix. Premium versions of Vista command higher prices. That mix, or ratio, was 75% for premium vs. basic editions in the quarter. That's a big leap from the 59% mix a year ago.

While preference for premium editions is stronger among consumers than corporations, home editions carry lower price tags. Business premium editions have a 5-to-1 "pricing impact" over consumer premium editions, said Colleen Healy, manager of investor relations. That means business premium editions may sell more slowly, but they rake in a lot more cash.

"We still think consumer

sales will grow faster than business, but it's a very good story on the client side," Liddell said.

The preference for premium software carries over to the server division, too, where premium enterprise editions of Windows Server grew 35%. The business division is expected to grow 31% to 32% in the current quarter, Liddell said.

That kind of server software growth is good news ahead of the release of the final version of Windows Server 2008, due out early next year. A pre-release version has been downloaded more than a million times since it came out just more than a month ago, indicating a high level of interest in it, Healy said.

Even with

Halo 3

going gangbusters, entertainment and devices division revenue will be "flat to down," for the current quarter.

"Our performance is going to continue, but not at the same rate," Liddell said, wrapping things up.

"We expect EPS to grow very fast as well." Already growing faster than 20% this year, the bottom line will continue to benefit from operating margin expansion and share buybacks, Liddell added.