You'd expect Microsoft (MSFT) to keep a spotlight on its big moneymakers Windows, Office and Servers -- after all, they do generate more than 80% of the company's sales.
But the software giant also is busy readying its so-called emerging-business units for their close-up. For two of the four, MSN and Home and Entertainment, which represent 15% of the company's trailing 12-month sales, the future is nigh, say analysts.
Microsoft is pumping substantial sums and energy into those often-neglected units, hoping the investment will drive future growth.
In a November research note, Pacific Crest Securities analyst Brendan Barnicle put a number on just how much Microsoft's emerging businesses could matter in coming years. He projected that they could flip-flop from being a drain of 5 cents a share on Microsoft's earnings to boosting earnings 13 cents a share by fiscal 2008. (Barnicle or a member of his family holds Microsoft shares.)
The analyst believes that the biggest opportunity for upside is in Microsoft's MSN Internet division, which first operated in the black in fiscal 2004. He suggested that online advertising will help MSN sales grow 14% in fiscal 2007 and achieve a 40% operating margin.
Microsoft has been trying to more aggressively compete against the search businesses of both
, and some investors have taken notice.
Loomis Sayles & Co. analyst Tony Ursillo noted at a recent demonstration how Microsoft's Encarta encyclopedia answers users' questions instead of merely providing a list of Web sites that could offer such answers.
"The business is clearly a huge profit generator, and I think Microsoft has some unique intellectual property that it can bring to the game," Ursillo said of MSN search. (His firm holds Microsoft shares.)
High Hopes for Xbox
Still, Ursillo and others feel the company's Home and Entertainment division represents Microsoft's most important emerging unit.
Indeed, Merrill Lynch analyst Jason Maynard said the division represented the software titan's "biggest potential for a home run." Earlier this year, Maynard projected that the division could be profitable in fiscal 2006 or 2007 -- conceivably earlier than Microsoft has predicted. (Maynard has a buy rating on Microsoft, and his firm has done non-investment-banking business for Microsoft.)
The biggest portion of sales in the division come from Microsoft's Xbox video-game console. Microsoft is expected to launch the next version before the 2006 holiday season -- crucial timing, because it's expected to come ahead of rival
"That's absolutely the most important driver among the emerging businesses, because it has size," Ursillo said. "And there's an established business model from Sony that shows it can work as a business."
Though Microsoft loses money on every Xbox sold, Ursillo and others believe that loss should shrink with the next-generation console and be offset by more profitable video-game sales.
An often overlooked component of Microsoft's Home and Entertainment division is Microsoft TV, which is also starting to show some success after years of fine-tuning.
After investing $6 billion in
and missteps building software for expensive, futuristic set-top boxes, Microsoft is now taking a two-pronged approach to turning its operating system into a television backbone. First, the company has developed what it calls Microsoft TV Foundation Edition -- software targeted at set-tops that already are sitting inside people's homes.
Microsoft announced last month that Comcast is debuting Foundation Edition for the first time in the U.S., in Washington state. Outside of the U.S., about 40% of the digital cable market in Latin America is running Foundation Edition, according to Microsoft.
In addition, Microsoft announced a second, next-generation product last year called Microsoft IPTV, or Internet protocol television. It enables operators to offer an array of services such as video, voice and data over a single network connection. Microsoft was surprised at the level of interest shown by telecom companies as they edge into cable's TV turf, with
signing a $400 million, 10-year deal for millions of licenses of IP TV to sell to subscribers.
But Matt Rosoff, an analyst with independent Microsoft-tracking firm Directions on Microsoft, still cautioned that IPTV is a "long-term bet" that will require "pretty expensive infrastructure investments" from operators.
Another emerging unit, Business Solutions, is also turning out to be a longer-term bet than investors -- and probably even Microsoft -- expected. The company has said that selling accounting and customer management software to small and medium-size enterprises should grow into a $10 billion venture. But perhaps not coincidentally, just when Microsoft believes it would reach that goal remains unclear.
Since Microsoft's $1 billion-plus acquisitions of business software makers
in 2001 and
in 2002, the segment has underperformed expectations.
"It has grown slower than I would have thought and has yet to reach profitability, when it should have," Ursillo said. He chalked up the weak results to a lack of urgency to achieve a profit, product delays and other execution issues.
"That business I think is really in show-me mode with investors," Ursillo said.
Indeed, Barnicle forecast that even by fiscal 2007, business Solutions is likely to generate less than $1.5 billion in revenue, resulting in upside of 2 cents a share based on a 20% operating margin.
Meanwhile, Microsoft's fourth emerging business -- Mobile and Embedded Devices -- is still too meager to make a dent in a $38 billion behemoth like Microsoft. The segment is focused on selling Microsoft software to the smartphone and handheld markets.
Microsoft's operating system for personal digital assistants
recently nabbed the lead position from the well-known Palm OS, according to research firm Gartner. But that's a stagnating market expected to be overtaken by smartphones, where more than 80% of the market is dominated by
, a former joint venture of several handheld makers now controlled by
, according to ABI Research.
ABI analyst Brian Pellegrini notes, however, that Microsoft got a late start in the cell-phone market. Since its entry a year ago, the company has partnered with all of the major North American cell-phone operators as well as with more than 60 mobile operators worldwide to sell a phone with Windows Mobile, according to the company.
Pellegrini believes that by 2009, Symbian's share of the mobile-phone OS market could fall to less than 50%, with Microsoft seizing the remainder. That's because Symbian is targeting primarily higher-end phones, a tiny part of the market, while Microsoft makes an easier, though less stable OS, Pellegrini said.
However, Whyman and other analysts believe that Microsoft faces an uphill battle in the mobile-phone market. "All of the carriers are scared to death of letting Microsoft into the business," Whyman said. "They're afraid Microsoft will relegate them to a commoditized portion of the solution."
And of course, they take their cue from the cutthroat PC market, where Microsoft made a killing with its Windows and Office software. If Microsoft can apply that model to its up-and-coming businesses, it just might coax out stellar performance.