Microsoft Corporation (MSFT): Is The Surface Tablet a Dud?

From an advertising standpoint, Microsoft Corporation (NASDAQ:MSFT) has made quite a splash with its Surface tablet (check out its latest TV spot here), but a recent note from FBR Capital Markets analyst Craig Berger suggests that sales have been "disappointing" this quarter.

Originally reported by Adrian Kingsley-Hughes of ZDNet, Berger shares with clients that demand for the Surface has "underwhelmed expectations," which were quite low to begin with. In the article, Kingley-Hughes discusses that "Microsoft was only expecting to shift between 3-5 million Surface tablets this quarter in the first place," which pale in comparison to Apple Inc. (NASDAQ:AAPL), which "sold three million iPads in the first weekend alone following the release of the iPad mini and the iPad 4."

While this note, if proven to be correct, may certainly spell trouble for Microsoft's own tablet, it's worth mentioning that the Windows 8 operating system -- at least in the tablet arena -- is expected to perform quite well, according to the latest research report from IDC (which we discuss in detail here). In the report, Microsoft Windows's share of the worldwide tablet market is expected to be 10.3% by 2016, up from the 2.9% it's predicted to hold by the end of this year. In terms of actual growth, IDC forecasts that Microsoft Windows will experience a CAGR of 69.2% over this five-year timeframe, far above Apple iOS (20.9%) and Google Inc (NASDAQ:GOOG)'s Android (21.0%) operating system.
Thus, Microsoft's main issue looks to be finding an adequate entry into the hardware space that consumers will prefer over other Windows-bearing brands like Asus, Acer and Lenovo. At a price point equal to that of Apple's iPad and above the iPad Mini, the Surface may not be differentiating itself from the competition enough, even if it has that handy-dandy cover keyboard.
The next logical question that investors must ask is: what does Microsoft have up its sleeve? Well, looking at rather insightful PCWorld piece, "the company plans to launch three new devices in the next year," at least according to Twitter user “MS Nerd," a "well-known source of leaks."
While it's tempting to ignore these suggestions, it's worth mentioning that this particular source has been correct about Microsoft leaks before (though not always), and accurately predicted: (1) that Windows 7.8 would be used to give some features of Windows 8 to outdated hardware, (2) "the impending demise of Zune hardware," and (3) most of the Windows Phone 7 specs.
Sometime in 2013, the rumor foresees three new Surface coming from Microsoft, with the first being an 8.6-inch standard Surface (which is two inches smaller than the current model), the second being a Windows 8 Pro-equipped Surface with an 11.6-inch screen, and the third being a 14.6-inch device called the Surface Book. If these rumors are true -- and there's a possibility that they'll end up being off the mark -- then it appears that Microsoft is positioning itself to compete with the iPad Mini and the iPad by way of separate devices, while offering something in the form of a hybrid laptop-tablet with the 14.6-inch model.
If investors are looking to get into Microsoft based on its potential in the tablet arena regardless of this rumor, the stock's valuation indicates that now may not be a bad time to do so. At it's current market price in the $26 range, shares of MSFT trade at a mere 8.1 times forward earnings, which sell-side analysts expect to average EPS growth of 9-10% a year over the next half-decade. In comparison, Apple (9.9X), Google (14.9X), Oracle Corporation (NASDAQ:ORCL) at 11.1X, and International Business Machines Corp. (NYSE:IBM) at 11.4X, are all more expensive.
But that's not all. Microsoft sits on a mountain of operating and free cash flow nearly $60 billion high, yet trades at a paltry 7.1 times the value of this cash, which is below both the industry average (9.1X) and the company's own five-year historical average (10.1X). As you can probably expect, Microsoft's cash valuation is also cheaper than Apple (10.7X), Google (14.3X), Oracle (11.7X), and IBM (10.9X) by a modest margin. For income investors who are a bit hesitant on a pure value play approach, Microsoft also offers a superior dividend in comparison to most of the other players in the mega-cap tech arena, paying a yield of close to 3.5%.
To recap: while it's impossible to know for certain how Microsoft will handle the Surface in the future, bears should be careful to write off the company's tablet just yet, as it may still have some surprises up its sleeve, so to speak. From an investing standpoint, shares of MSFT look attractive nearly every way you slice it, and it's possible that we'll see solid value -- and income -- based appreciation going forward. For a longer look at Microsoft, check out its profile page on Insider Monkey.
Article Source: InsiderMonkey