Microsoft News Tracker

Back in February when the EU gave Microsoft the 899M euro bill for continued noncompliance beyond the original 2004 antitrust judgement, Microsoft gave no indication that they would do anything but grin and bear it. It turns out that wasn’t the case:

"Microsoft today filed to the (EU) Court of First Instance an application to annul the European Commission decision of February 27," Microsoft said in a statement.

"We are filing this appeal in a constructive effort to seek clarity from the court," it said.

Presumably they have some expectation of success, but given the poor outcome of their last venture before the Court of First Instance, it is hard to see why.

Shareholders were justifiably nervous after the first good news called out in the 3Q08 Microsoft earnings report was that the nearly profitless sinkhole of Entertainment and Devices grew revenues by 68%. That such a diversion was necessary was because the milk yields of Microsoft’s leading cash cows, Windows and Office, dropped in a still mostly unexplained manner.

Below are the segment breakouts with some brief commentary based on the 10-Q.

Client:

The big hit here is the $1.14 billion of deferred revenue that got tacked on in 3Q07, but even removing that, revenues were down over last year despite OEM sales (which account for 80% of unit sales) being up 5% and the "premium mix" being up as well. Estimated PC sales growth was 8-9% and theories ranging from piracy to Apple/Linux competition to Microsoft shifting revenue to next quarter have been offered for the shortfall.

Business (mostly Office):

Subtracting the $500M deferred revenue booked in 3Q07 makes this look much better apparently due to strong Office revenue growth from businesses, but consumer revenue was actually down. R&D expenses were up 19% driven by headcount expenses and headcount itself was up 7%, presumably not to add bells and whistles to the traditional Office product.

Server and Tools:

Another sterling quarter for Server and Tools who launched major new products.

Entertainment and Devices (mostly Xbox):

The good news is that E&D made money in 3Q. The bad news is that it didn’t make much, but then it never does. R&D expense was up 26% and sales and marketing expenses were up 29%.

Online Services:

Online advertising revenue grew 39% ($175M) to $619 million including aQuantive’s $47 million. aQuantive also added $97 million in agency revenue. So where did it all go? There was a large write-off from the acquisition of aQuantive plus increases in general expenses for infrastructure, "online content expenses," and headcount. One item that caught my eye was "a $24 million in-process research and development write-off." The Online Services Business (OSB) doesn’t seem to be going anywhere fast. The question, of course, is whether it would go any faster with the addition of Yahoo.

Corporate Level Activity (overhead and legal): 

The big ticket item here was an increase of $1.2 billion in legal expenses including the EU fine.

Bottom Line:

Out of Microsoft’s three cash cows (Windows Client, Office, and Servers) only Servers delivered in accustomed fashion. Entertainment and Devices is all sound and fury signifying nothing, while Online Services is treading water waiting for a Yahoo life preserver

Steve Ballmer’s three week ultimatum to Yahoo’s board of directors to accept the Microsoft acquisition offer passed yesterday with no comment from Yahoo or specific action from Microsoft to carry out the threatened reduction of the offer amount and proxy fight. The next episode in this soap opera is expected early next week and predictions range from Microsoft withdrawing their offer to a full out hammer and tongs proxy battle. The most telling commentary however is likely the desire of Yahoo employees to take the money and Microsoft employees to forget about the whole thing.

Matthew Karnitschnig and Kevin Delaney are reporting at the Wall Street Journal that “people familiar with the matter” say that Yahoo’s trial of running Google ads alongside Yahoo Search results was a success and that the Yahoo-Google Deal Advances. Since Yahoo announced the trial on April 9 and it was supposed to last two weeks, it seems a trifle premature to be declaring it a success. However, the general expectation has always been that running Google ads wiould pay better than Yahoo’s inhouse sales, so a positive result would be no real surprise.

The real question is what can Yahoo make of this in fending off Microsoft’s acquisition attempt since potential Google antitrust concerns cloud the picture. Because the relevant consideration with shareholders is how much they get up front and a Google deal has only an indirect effect on that, any such deal or deal rumor seems merely to be a bargaining chip that is hopefully worth a higher Microsoft offer.

Still, it has to rankle that Yahoo is effectively telling the world that if they could only get their act together, they could actually make significantly more money from Yahoo Search ad sales. It also raises uncomfortable doubts about how much Microsoft could make on the same search ads.

Just when the plot in the Microsoft Yahoo acquisition soap opera was getting a bit stale, some new twists were added today leading off with Yahoo announcing that they would be stepping out with Google for a two week trial run of Google ads on Yahoo search. The Google ads are only supposed to appear on 3% of Yahoo’s US search queries during the trial, but this solution has been advanced before as a way for Yahoo to leapfrog the problems with its troubled search ad infrastructure and make some real money off the Yahoo search gold mine. Needless to say, wannabe suitor Microsoft was displeased to hear that Yahoo was still playing the field and raised fears of a monopoly without actually using the “m” word.

Then to add insult to injury, word leaked out that Yahoo is pursuing nuptials with Time Warner’s AOL unit:

Under the terms being discussed between Yahoo and Time Warner, the latter would fold its AOL unit into Yahoo and make a cash investment in return for about 20% of the combined entity, people familiar with the situation said. The deal, which wouldn’t include AOL’s dial-up access business, would value AOL at about $10 billion. As part of the deal, Yahoo would use the Time Warner cash and additional funds to buy back several billion dollars worth of its own stock at a price somewhere in the middle of the range between $30 and $40 a share, the people said.

You may recall that Google owns 5% of AOL and handles their search ad business so Yahoo acquiring AOL and running Google ads would create a surprisingly homogeneous “content” and search company although not obviously a wildly profitable one.

Still, it’s all up to the Yahoo shareholders and which way they jump will mostly be determined by how much money they get upfront and not in some halcyon future. In that regard, Microsoft is rumored to be in talks with Rupert Murdoch’s News Corp. about merging MSN, Yahoo, and MySpace presumably with the objective of having News Corp. help Microsoft offer more for Yahoo. Since Google has the MySpace search ad contract and Microsoft owns part of MySpace competitor Facebook, such a plan would provide even more fireworks.

Stay tuned - there’s apparently life in this plot yet.