Microsoft’s Secret Weapon

03/18/2010 3:13 pm EST

Focus: STOCKS

Jim Jubak

Founder and Editor, JubakPicks.com

Microsoft (Nasdaq: MSFT) reported fiscal second quarter earnings on January 28.

The really good news for investors was what wasn’t in the blowout numbers. And what’s happened to the company’s business since then.

The second quarter results were good enough on their own. (Microsoft’s fiscal year ends in June.)

The company reported earnings of 60 cents a share. Once you added back in $1.7 billion in deferred revenue and about 14 cents a share in earnings from sales of Windows 7 that Microsoft decided it would recognize in future quarters, the earnings picture looked even better at 74 cents a share.

Wall Street analysts had included that deferred revenue in their estimates of 59 cents a share for the quarter. That made this a 15-cents-per-share earnings surprise.

The company attributed that extra pop to better-than-expected sales of its new Windows 7 and Windows Server 2008 R2 software launched in October. Through the second quarter, Microsoft had sold 60 million Windows 7 licenses, making it the fastest selling operating system in history, according to the company.

What’s really interesting for investors who want to know what the stock might do in the future, the company reported that it still hadn’t seen a significant contribution to sales from corporate—known as enterprise—purchases of Windows 7.  Pretty much all the strength through the end of 2009 had come from consumer purchases. In fact, booked sales in the key enterprise business of servers and tools were flat, and business division sales actually declined 5%.

When will those enterprise sales kick in? It looks like that will begin in the second half of calendar year 2010 and then really build up speed early in calendar year 2011.

By early March, Wall Street analysts were reporting that their checks of sales channels showed significantly more companies signing up to beta test Windows 7. (No company in its right mind buys a new operating system until it has a chance to see how it runs with existing applications software.)

The stock actually sold off big on the day after the earnings announcement and then continued down until it hit a bottom, along with the rest of the market, on February 8. (For another stock that sold off on great long-term news, see this recent post on Cisco Systems (Nasdaq: CSCO).)

I suspect the rebound since then is one part general market recovery, one part buying by value investors who like the long-term story (if 2011 is considered long term), and one part Google/China hype. Wall Street has been abuzz with speculation that Google’s (Nasdaq: GOOG) potential departure from China will be a boon to Microsoft, which has struggled to gain traction in China’s huge Internet search market. The buzz got louder with the news that Microsoft has, according to the Wall Street Journal, hired three people from Google’s China unit.

Interesting to speculate about, but I’d rather put my money on an increase in sales to corporate customers. As of March 18, I’m raising my target price to $36 a share by October from the prior $33 by June. (It traded just below $30 on Thursday afternoon.)

Full disclosure: I own shares of Microsoft in my personal portfolio, and of course, my commentary and videos appear on MSN Money.

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