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Monday, July 15, 2024

X Marks the Spot

Unless you live in some kind of media blackout zone you are probably aware that the XBox 360 is coming next week so, like many of you, I’ve been buying MSFT stock even as it keeps going up. Because it is still way too cheap!

Although the stock has been parabolic since breaking its 200 dma way back at $25 (On Halloween and congrats to CSFB for making that call on the 28th) I think it can go to $29.50 before a big correction. It may even just pause around there to consolidate for another jump, we’ll have to wait and see. The current p/e is 23.7, I think 25 will freak people out and cause a pullback, that’s about $1 away.

I think the Microsoft corporation under Balmer is firing on all cylinders and they have played the publicity/anticipation game perfectly with 3M consoles expected to be sold between now and Xmas eve. The gaming industry has had a notably slow quarter as everyone has been saving their cash for either this one or the Sony which won’t be out until Spring.

So Christmas belongs to Microsoft and all the companies that make games for them. Figure 5 games sold with each console so 15M games will be sold with the 3M units. The games cost about $30 each (I know, crazy!) so that’s $450M in game sales.

The trick will be to track the top selling games on Amazon and buy those companies into earnings – never try to guess what will be popular, it’s like picking next year’s fashions…

So Microsoft will sell 3M XBox 360s this quarter and people will buy their stock in some sort of frenzy over the $1.2Bn in revenue that will generate. While that may be a huge number – even for a company that has $40Bn in revenues, I think perhaps people are slightly overestimating the impact of that one item so expect a pullback when XBox fever abates.

Microsoft sold 10M old Xboxes last year, although the new unit is more expensive, I am pretty sure the company makes little or no money selling them, consoles are a loss leader to sell games. So we will be adding, for argument’s sake, 10% to sales without increasing profits – this is frowned upon by wall street.

On the plus side, we know Microsoft spent $4Bn developing the first XBox. Although they are very tight-lipped about the cost of this one, let’s assume they saved some money and only spent $3Bn on the new one. That’s $250M a month of R&D that can now move to the bottom line! Now we are getting somewhere, although they’ll probably just blow it all on the XBox 5th Dimension or whatever they need to come up with next to convince us that the last one we bought is now lame.

Not that Microsoft needs to move anything to the bottom line – on $40Bn in sales for FY2005, the company made $16Bn pre tax – that’s 40%!!! That’s after spending $6Bn a year on R&D. Why do they spend so much on R&D? Because they can’t find anyone to buy who makes that kind of money so they have to do everything themselves.

Not even the Great Google makes 40% on their sales! The XBox 360 will add about 10% to sales and, by the end of the year, game licensing will equal profits but the real story of next year will be the new version of windows. When windows ’95, ’98 and XP were released sales went up 20% in those years and the year after that! It has been a while since we had a new operating system and we can expect this one to be a biggie.

Even if the new system fizzles, the higher pricing and higher licensing fees across the product line (which we all have just bent over and accepted already) should combine to give Microsoft an easy 20% kick this year and next. That will be $16Bn in additional sales for 2007 with another $4Bn in profits (assuming they ramp keep R&D at 15% of sales – if not, there will be another $2Bn floating around).

That translates into a p/e of 19, all else being equal. The company has 10x Googles revenues, 16x Google’s profits and costs 1/4 of what Google costs. Google will have to grow at 80% (4x Microsoft’s growth) every single year to justify that valuation.

As you know from other articles I’ve written though, I think Google’s well worth the price so we can only conclude then that Microsoft must be very, very cheap.

Google has a majority of the search market – Microsoft has a virtual Monopoly in operating systems (they already paid the fine). Virtually every single one of the 1Bn computers on this planet boot up with windows every day, it is probably the most common of all shared media experiences. Look around your computer screen and what do you see – Google or Microsoft?

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