Microsoft: Not Bad, Not Good

Huge cash reserves. Aivars lode Avantce

Microsoft: Not Bad, Not Good MSFT reported headline results that were about in line with sell side estimates, though probably better than real expectations when recent PC shipment data is fully considered. A closer look indicates a quarter that was more reflective of a struggling PC market, as channel inventory build probably helped the Windows business, and Surface shipments were likely disappointing, which should not be surprising. ·         Details. EPS of $0.76 (with $0.02 from a lower tax rate) on total revenue of $21.5B was about in line with consensus estimates of $0.75 and $21.6B, but better than our $0.68 and $21.0B, respectively. We believe that consensus sell side estimates may have been greater than true expectations since not all analysts had updated their estimates to reflect recent dismal PC unit shipments. Gross margin of 73.5% was about 260 bps better than we modeled. Operating cash flow declined 18% from a year ago to $4.8B and was below our $5.4B estimate, while deferred revenue of $19.8B was better than the consensus estimate of $18.9B and our $18.2B. ·         Windows inventory math. The Windows business continues to be coupled to the PC market, despite what appears to be a disconnect in the December quarter results. We believe the 900 bps outperformance of Windows relative to the PC market was primarily due to a build up of inventory in the PC OEM channel, as OEM partners built inventory in anticipation of the launch of Windows 8, like they typically do with any Windows launch. ·         Surface math. Although management chose not to disclose shipments of Surface units, we estimate shipments of 600,000 to 800,000 units, as detailed herein. ·         Model changes. Our MarQ GAAP revenue and EPS are now $20.5B and $0.74 vs. $20.8B and $0.72 previously; our FY2013 GAAP revenue and EPS are now $78.9B and $2.75 vs. $77.8B and $2.62 previously; and our FY2014 GAAP revenue and EPS are now $83.7B and $3.00 vs. $82.9B and $2.91 previously. ·         We continue to rate shares of MSFT Neutral with a December 2013 price target of $30 based on our DCF.