Microsoft: What Growth Slowdown?

Citing opportunities online and abroad, executives in Redmond project sales will grow faster than the company's size would lead investors to expect

In recent years, Microsoft (MSFT) executives have often told eager investors longing for the glory days of the 1990s that its financial results were limited by "the law of large numbers"—its reference to slowing growth as the company got bigger. The days of revenue growth north of 20% were long gone as annual sales climbed to $51.1 billion.

But in the last five years, Microsoft's revenue has nearly doubled while its profit has more than doubled. And it's projecting sales growth of 11% to 13%, from $56.8 billion to $57.8 billion, in the fiscal year that ends June, 2008. The high end of that range would match or exceed the pace of growth in three of the past five fiscal years. "When is the law of large numbers going to catch up?" asked Microsoft's Chief Financial Officer Chris Liddell at the company's annual financial analyst meeting on July 26. "It's not going to be next year."

The full-day affair for investors, analysts, and the media at the company's Redmond (Wash.) headquarters afforded Microsoft an opportunity to rally Wall Street around its shares, which have traded largely sideways during the past half-decade. Chief Executive Steven Ballmer said the company was poised to grow faster than any company its size should. "We have more opportunity to deliver innovation and growth in the next 10 years than even in the past 30 years of the company's history," he said.

Business Development

Ballmer ticked off a list of seven business opportunities where he believes Microsoft can generate at least $500 million in new gross margin growth, per business, over the next three years. That ranges from software for servers, the computers that run Web sites and corporate networks, to Xbox games and accessories, a business where Microsoft has been limping of late (see, 7/6/07, "Microsoft's Billion-Dollar Fix").

Whether Microsoft can execute well enough to generate that much in new business remains to be seen. "It's hard to judge," says Charles Di Bona II, senior research analyst at Sanford C. Bernstein & Co. "The opportunities are there." Microsoft shares fell 73¢, to $29.98, though it was a tough day for equities all around (see, 7/26/07, "An Ugly Day for Stocks").

Surfing for Revenue

Perhaps the biggest area of new growth will come from online advertising, where Microsoft has spent billions of dollars building its own technology. And it's about to spend $6 billion more to acquire online advertising powerhouse aQuantive (see, 5/18/07, "Microsoft's Big Online Ad Buy"). "We are hell-bent and determined to allocate the talent, the resources, the money, the innovation, to absolutely become a powerhouse in the ad business," Ballmer said. The company says more acquisitions are needed to get there. One came the same day, as Microsoft announced the purchase of ad-auction network AdECN. Terms weren't disclosed.

To boost the online business, Microsoft plans to launch a new version of its Windows Live Web services later this year. Those are technologies where users log in to personalized services, one of the few Net businesses where Microsoft has a lead over Google (GOOG) and Yahoo! (YHOO).

And the company continues to target Web search, where it trails both Google and Yahoo, for new growth opportunities. Kevin Johnson, president of Microsoft's platforms and services division, said the roughly 230 million Web surfers who use Microsoft's search engine each month are close to the 240 million who use second-place Yahoo's technology. The big difference in market share, though, occurs because Yahoo users return 18 times a month, whereas Microsoft users only return eight times a month. Johnson believes better search results will improve that number. "Before we get to No. 1 in search, we're going to have to pass No. 2. And that's our next step," Johnson said.

Emerging Markets

Like a handful of other big tech companies, Microsoft is finally finding meaningful growth in emerging markets. The software giant expects PC unit sales to grow 16% to 18% in the developing world during the next two fiscal years, well ahead of the 6% to 8% in developed markets. And even though consumers and businesses in those emerging markets are less likely to buy premium versions of Microsoft's software, they are becoming meaningful sources of revenue.

That's mainly from the biggest of the emerging markets: Brazil, Russia, India, and China. Microsoft believes there is still much untapped potential in the more extreme emerging markets, where technology is only beginning to reach critical mass. "We put together a strategy to be able to really get after the next tier of emerging markets," Chief Operating Officer Kevin Turner said.

Now Microsoft just needs to "get after" an unconvinced investor base.

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