Microsoft's new Windows a hit, but no revolution

SEATTLE Fri Oct 16, 2009 2:33pm EDT

SEATTLE (Reuters) - Investors expecting Microsoft Corp's (MSFT.O) new operating system to juice the company's shares or spur a recovery in technology spending are likely to be disappointed, even if users embrace the new software.

A successful introduction of Windows 7 next week has largely been factored into Microsoft's share price, which jumped nearly 80 percent since March. Investors are now more wary of a sell-off than looking for further gains.

The new operating system, arguably Microsoft's most important product launch since Windows 95 a decade ago, arrives as demand is growing to replace aging software and hardware.

Some hope it will energize a corporate spending cycle curtailed by the worst recession since the Great Depression, but most analysts agree that its effect on Microsoft and the broader technology sector will be more gradual.

"I'm not expecting this huge wave in new revenue," said Kim Caughey, senior analyst at Fort Pitt Capital Group, which holds Microsoft shares. "It's going to be more of a gentle drift upward."

PC sales are expected to rise 12.6 percent next year, according to research firm Gartner, but the strength of the next phase of computer buying is at the mercy of the economy.

"There's pent-up demand for a better operating system that will start unfolding next year," said Sid Parakh, an analyst at brokerage McAdams Wright Ragen. "But that is conditioned on what the economy does from here. If things get a lot worse, we shouldn't expect as big of an upgrade cycle as everyone is thinking about today."

BOTTOM-LINE IMPACT

The new operating system, which has been available in test format for months, has been praised by reviewers as a replacement for the unpopular Vista, launched almost three years ago.

The new system is more of an upgrade to Vista than an overhaul, and is expected to work on most PCs without a hitch. Computer and chip makers such as Hewlett-Packard Co (HPQ.N), Dell DELL.O and Intel (INTC.O) have welcomed its release.

But even a flawless roll-out may not be enough to kick-start a new spending cycle.

"At best, Windows 7 may generate a modest bump in home demand and possibly some added demand among small businesses," said Gartner's research director George Shiffler.

"We aren't expecting most larger businesses, governments and educational institutions to express strong demand for the new operating system until late 2010."

The effect of Windows 7 on Microsoft's finances is not straightforward.

First, many of Microsoft's corporate clients don't make one-time software purchases. They have long-term subscriptions called enterprise agreements that involve "software assurance," which means customers are entitled to the latest versions of systems or applications in the agreement.

Consequently, many companies have in effect already bought Windows 7, regardless of whether they install it.

The financial effect of licensing the operating system to PC makers is also difficult to gauge. Microsoft closely guards what it charges, but it is no secret that prices have been under pressure as PC sales have waned.

The rise of cheap netbooks -- compact laptops chiefly for e-mail and web surfing -- means Microsoft will sell a growing proportion of the cheapest version of Windows 7 for PC makers to install.

As for individual customers, Microsoft chief financial officer Christopher Liddell said last month that off-the-shelf sales of Vista contributed $200 million to $300 million to revenue in the months after launch, and he was expecting similar or greater for Windows 7.

That is tiny for a company that booked overall sales of $58 billion in the last fiscal year.

CLOUDY FINANCIALS

Results for the first quarter of Microsoft's current fiscal year are scheduled for next Friday, the day after the launch of Windows 7.

Wall Street expects revenue to fall to $12.4 billion from $15 billion a year earlier, according to Thomson Reuters I/B/E/S, while operating profit is also seen declining.

This is partly due to more than $1 billion in revenue from sales of operating systems in the quarter being deferred, because Microsoft is guaranteeing a free upgrade to customers who recently bought Vista.

That, along with holiday sales, explains why analysts are expecting a surge in revenue to $17.1 billion for its fiscal second quarter, which ends in December.

All of this means that the financial effect of Windows 7 may not be clear for some time, said Michael Cherry, an analyst at Directions on Microsoft, an independent consultancy.

"If in six months we aren't seeing people willingly buying this system, then there's a problem."

(Additional reporting by Gabriel Madway; Editing by Edwin Chan and Derek Caney)