Big change may not be change enough for MicrosoftJuly 22, 2013: 9:33 AM ET
Its preemptive moves don't change the fact that the company has big questions to answer.
By Kevin Kelleher, contributor
FORTUNE -- Preemption is one of the handiest tools in the art of public relations. If a company can get ahead of news -- especially not-so-good new -- it can control the tone of the conversation and even guide it in a direction that plays up the company's strengths.
The ambitious restructuring that Microsoft (MSFT) announced earlier this month looks to have been a preemptive move. Not the restructuring itself, which has been in the works for some time, but the timing of its announcement: a week before Microsoft was going to announce earnings that fell short of what Wall Street had been expecting.
It's not clear the strategy worked this time. In fact, Microsoft may have offered a case study in how preemption can go wrong. Rather than steering the conversation toward Microsoft's future (a tech giant refitted to better handle what's coming) and away from the past (a juggernaut tied down to the aging market of desktop computing), Microsoft appears to have entered a vacuum of uncertainty.
On July 11, Microsoft announced a long-awaited restructuring that sought to turn its scattered fiefdoms into a more integrated confederation. Myriad operating systems, long the company's core technology, would be consolidated under one engineering division. Hardware devices would be grouped in another, enterprise in yet another. Over the several following days, the stock gained 5% on the news that the company was shifting its focus on growing markets like cloud services, mobile devices, and apps.
Never mind that the restructuring drew comparisons to Apple (AAPL) at a time when Apple's future is a matter of debate. Never mind that the single strategy the company was uniting behind -- "to help people realize their full potential" -- sounded more like the job description of a life coach. Microsoft's stock was drifting up to its highest level in nearly six years. The future looked brighter for the company than it had in some time.
Then came earnings.
Microsoft said last Thursday that revenue rose 10% on year to $19.9 billion in its fiscal fourth quarter, while net income came in at 59 cents a share. Analysts had been expecting $20.7 billion in revenue and 75 cents a share in profit. Everyone knew that the weak demand for desktops and laptops was hurting Microsoft, but they underestimated the damage. Microsoft said that, while shipments of those PCs to companies rose in the single digits, consumer PC shipments fell 20%.
On top of that, demand for Microsoft's Surface tablets has been disappointing enough to prompt the company to write down $900 million in inventory. That writedown, which few if any investors were expecting, deleted 7 cents a share from its net income. Microsoft cut Surface RT prices by $150 to $349, and adjustments to "related parts and accessories" also added to the writedown.
There were bright spots too: Office 365, Outlook.com, Skype, and Xbox LIVE are seeing increased demand from consumers, CFO Amy Hood pointed out. But the gloom of the PC and Surface news seemed to obscure those bright spots. An analyst at Citigroup bluntly called it "the sloppiest quarter in memory."
Looking ahead, things weren't any brighter in the near term. Hood warned that Windows revenue from PC manufacturers like Dell (DELL) and Hewlett-Packard (HPQ) would decline by around 15% in the coming quarter. Goldman Sachs predicted that lower prices of tablets and smartphones and piracy in emerging markets would weigh on future earnings. Cost of goods sold will stay high because of cloud infrastructure and Surface manufacturing. And if Microsoft keeps spending on promoting the Surface, marketing costs will stay high as well.
Investors took the news pretty hard. Several analysts downgraded the stock. Microsoft shares, which closed at $35.44 on Thursday, opened at $32.40 Friday and by the end of trading had sunk further to $31.40, erasing nearly three months of steady gains. In one day, Microsoft dropped 11.4%, losing $34 billion in market value. Put another way, if Yahoo (YHOO) lost that much market value, it would be worthless.
All that bad news took the wind out of the restructuring announcement. Any optimism that an ambitious restructuring would reverse these worrisome trends longer-term was offset by a concern that, in the months it would take for Microsoft to complete its ambitious turnaround, it would have to navigate some rough waters. And even then, there's no assurance the new Microsoft structure will make it more efficient.
The hopeful news about a new, more focused Microsoft was undone by the grim sight of a messy financial quarter, with no clear turnaround in sight. You have to wonder if Microsoft would be better off had it announced the restructuring after the earnings report, so it could argue: Look, we have this under control. We're taking care of it.
As it is, both pieces of news have left Microsoft's future looking more uncertain than ever. Among the few voices arguing for the stock were analysts at UBS and Nomura, who predicted shareholder activists would start agitating for moves that benefit investors. Sure enough, late Friday Reuters reported that Microsoft is talking with one such investor about a board seat. Big changes are only beginning at Microsoft, only now they may start coming from outside the company.