How Microsoft (MSFT) Makes It Back To $35

Microsoft traded at more than $35 in late 2007. It has not traded anywhere near that level since early 2008. Most analysts blame the poor reception for the company’s latest operating system, Vista, and concerns that the firm’s pursuit of Yahoo! (YHOO) and Google (GOOG) in the search market will continue to fail no matter how much money Redmond invests.

Microsoft’s stock could move above $35 by the end of the year even if the broader market stays at it current level. The increase, which would be a substantial 45%, would be based on two factors.

The first catalyst that could cause investors to view Microsoft as a growth stock would be a home run for its new search technology, Bing. Early research reports show that Microsoft’s share of the search market in the US may have moved up from 8% or 9% to 13% since the Bing launch. It is not clear whether that has come at the expense of Yahoo!  (YHOO) or Google (GOOG), but if the gain holds the world’s largest software company will have broken the back of a critical market. The success would also put pressure on rival Google which has used its dominant presence in the search market to begin to attack Microsoft  Windows in the desktop application business.

Microsoft’s success with Bing would have to be accompanied with a pullback on its commitment to spend 5% to 10% of its operating income on search over the next five years. This could be as much as $20 billion and would hurt Microsoft’s earnings over the entire period.  The company’s EPS have already been damaged by the recession. Bing needs to gain market share with a much smaller investment. The product has to be good enough to gain ground with much more modest financial support.

More important to Microsoft’s success is a very successful launch of Windows 7, the replacement for Vista. The public release of the operating system is scheduled for October 22. Figures on initial sales should be available before Christmas. Vista sold 20 million licenses in the first two months after it was released. Redmond will have to announce that Windows 7 has sold closer to 25 million copies to make Wall St. believe that the operating system franchise ,so critical to Microsoft’s growth and profits, has not continued its decline.

It is possible that both the launch of Bing and Windows 7 will under-perform investor expectations. Microsoft shares could go back to below $15, where they traded in March.

Douglas A. McIntyre