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An Unfinished Story

Microsoft is planning to invest so much money next year that it will depress its future earnings. But both financial analysts and Microsoft partners will have to wait until July to find out where all that money will go.

Wall Street reacted swiftly to Microsoft's disclosure during the company's third-quarter earnings call that its projected earnings for fiscal 2007 (July 1, 2006-June 30, 2007) would be well below analysts' expectations. The next day, April 28, Microsoft's stock plunged 11 percent, the largest single-day drop in Microsoft's stock value in five years. The decline wiped out about $32 billion in Microsoft's market value, the equivalent of about $3 billion for Bill Gates and $1 billion for Steve Ballmer.

In published interviews, analysts reported feeling blindsided by the news. With Microsoft's investments in developing SQL Server 2005, Windows Vista, Office 2007, Exchange Server 2007 and Windows Longhorn Server, the view from the Street had been that 2007 was a time for Microsoft's profits to soar. With so many years between major releases, investors had hoped that all Microsoft's spending on product development would finally pay off.

But the company's forecast for its fiscal 2007 calls for operating income of about $19 billion on revenues of about $50 billion. The company's diluted earnings per share projections of $1.36 to $1.41 were lower than analysts expected. Reading the tea leaves behind Microsoft's earnings-per-share projections, analysts see Microsoft spending about $2 billion more than the outside experts had anticipated.

The prevailing view: Spending will be devoted to the company's efforts to challenge Internet search engine rivals Google Inc. and Yahoo Inc. Despite trying to boost MSN Search, Microsoft has actually been losing ground against its search rivals in recent user-behavior surveys. Meanwhile, MSN revenue actually declined during the financial quarter. The business segment saw revenues fall 3 percent to $561 million and swung from being $102 million in the black to $26 million in the red. The MSN division reportedly has about 20 Internet service projects in development.

Initially, Microsoft said it wouldn't give any details on its R&D plans until a July analyst meeting. But as the stock price fell, Ballmer provided more tidbits for fiscal 2007: MSN R&D will get $1.1 billion and capital expenditures will be $500 million. "We have told our R&D folks that our number one priority is software as a service," Ballmer said.

Meanwhile, Microsoft invested in the channel for its traditional businesses during its third financial quarter, which ended March 31. It spent $68 million more on partner marketing and Windows Vista pre-launch programs than it had the year before in the client business segment. Within Microsoft Business Solutions, an increase in sales and marketing expenses also reflected channel development.

About the Author

Scott Bekker is editor in chief of Redmond Channel Partner magazine.

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