BullMarket bets on Microsoft (MSFT)

By Geoff Seiler, BullMarket.com

Microsoft (NASDAQ: MSFT), already a holding in our model portfolio, recently reported a big jump in profitability for the final three months of 2009.

Investor reaction was muted, however, as there was a wide divergence in spending for the company's software products by enterprise and consumer clients.

Regular folks ponied up the cash in droves for new PCs running Windows 7, but businesses continued to sit on their wallets. The bottom-line results were impressive nonetheless.

Microsoft's net profit for its fiscal second quarter ended December 31st jumped by 60% year over year, paced by a 70% increase in sales at the company's Windows division.

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Windows 7 sales more than offset a -3% drop in revenues at Microsoft's Business division, which is home to the Office product line; a modest 2% sales gain at the Server & Tools division; an -11% sales decline at the Entertainment division; and a nearly -5% revenue drop at the Online unit.

The bottom line was that Microsoft earned $6.70 billion, or 74 cents per share, compared with $4.17 billion, or 47 cents per share, year ago. Revenue increased by 14% to $19.0 billion.

The sales results included $1.7 billion in deferred revenue from sales of Windows 7 made before the product was released. Excluding the deferred revenue, overall sales grew by 4%.

There was little impact from foreign exchange, the company said. Microsoft had preannounced it would book the deferred revenue in the fiscal second quarter. The consensus estimate from Wall Street was that the software giant would report EPS of 59 cents on sales of $17.8 billion.

Windows division sales, excluding the $1.7 billion in deferred revenue, grew by a robust 28% to $5.2 billion. The company credited a 21% increase in revenue from PC makers, which grew faster than PC shipments for the first time in eight years.

Through the end of the second quarter, Microsoft sold more than 60 million Windows 7 licenses, making it the fastest-selling operating system in the company's history.

Windows is attached to more than 90% of netbooks, with Windows 7 accounting for well over half of that number, the company said. Windows consumer licenses grew more than 35% year over year.

Microsoft's results played out exactly as we predicted in our earnings preview last week: the company delivered a solid earnings beat driven by strong consumer purchases of PCs with Windows 7 and investors reacted by taking profits. The company's outlook remained somewhat cautious, but the future earnings potential of the company is pretty clear.

Consumers will keep buying netbooks and notebooks with Windows 7, especially as the economy slowly improves. Corporations are likely to start upgrading their PCs and laptops as the calendar year unfolds, but that means a lot of the benefit to Microsoft won't show up until its fiscal fourth quarter that ends June 30th, but it should continue into fiscal 2011. The next fiscal year will also benefit from the June launch of Office.

With solid potential for growth in its core product lines, and $9.4 billion in cash on the books, Microsoft remains a "Buy" for long-term investors, especially on pullbacks. The company posted solid results, but the best is yet to come, as an eventual corporate upgrade cycle should help propel results over the next few years.

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