Microsoft's cautious outlook

October 23, 2008: 11:11 PM ET

By Yi-Wyn Yen

It's hard to believe that just four months ago Microsoft dangled a nearly $48 billion bid in front of Yahoo.

A souring U.S. economy has changed all that. During Microsoft's earnings call with investors Thursday, chief financial officer Chris Liddell made no mention of the Internet portal or any other potential big acquisitions. The company reported a solid first fiscal quarter, with revenues increasing 9% to $15.06 billion from the year-ago quarter. Profit rose 2% to $4.37 billion. But citing the "challenging economic environment," Microsoft cut growth projections for 2009 and focused on ways to rein in costs.

When asked by an analyst what kind of acquisitions Microsoft (MSFT) will make, Liddell offered a modest spending outlook. "We will continue to buy small to medium businesses, our sweet spot," Liddell said. "I don't see us necessarily increasing our acquisition volume. To the extent that we do buy, it'll cost us less."

Microsoft has a lot of money, and could certainly afford to buy Yahoo (YHOO) if it wanted. On Sept. 30, Microsoft had $20.7 billion in cash. (That's after the Redmond-based company spent $6 billion buying back its own stock last quarter.) With a current market cap of $17.5 billion, Yahoo is a bargain.

Microsoft certainly needs to do something to grow its online business. The company's goal is to compete with Google (GOOG) for Internet dollars, and Microsoft is unlikely to get there on its own.

The company grew its online service revenue 15% to $770 million for the quarter. That was better than Microsoft's projections of $718 million to $745 million for the online services unit, which generates revenue from Live search and MSN display ads. However, Microsoft has significantly cut its year-end projections to reflect the tough ad environment. For fiscal 2009, Microsoft expects its online business to grow just 10% to 13% compared to 18% to 20% from its last quarterly estimates.

The cost to run a third-place online advertising business is growing too. The company had an operating loss of $480 million for the first fiscal quarter, an 80% increase from the same period a year ago. Microsoft blamed the bulks of the costs on data centers and expenses related to its aQuantive advertising unit, which rose 47% to $183 million. Microsoft's online business makes up a mere 5% of quarterly revenues.

The company  may rely on its Office suite and server and client businesses to get through an ailing economy, but the company has repeatedly stated that its future lies in its least profitable group, the online businesses. Perhaps that's why Liddell didn't close the door entirely on a big shopping spree within the next year.

"We're still very cash rich, and that's a good environment for us," he said. "The limitation isn't the capital, but if we have the product road map and ability to integrate [companies]."

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