Microsoft’s Cloud Strategy Crippling Margins, Could Impact 2012 EPS

There was never a question of whether Microsoft should invest in the cloud or not.

As a tech heavyweight looking for a new growth sector, the hot cloud computing market looked like the perfect fit for the guys in Redmond.

From a high level, cloud computing is a huge technological shift that allows consumers and businesses to store their files on third-party servers. Although this market is still relatively new, competition has already arrived and it’s a virtual ‘who’s who’ of Silicon Valley.

Competitors like ($CRM), Google ($GOOG), ($AMZN), and Apple ($AAPL) already have their own cloud platforms and Microsoft is playing a game of “catch-up”, according to Goldman Sachs analyst Heather Bellini.

Microsoft has historically sold “pre-packaged” software at local retailers like BestBuy, so this cloud strategy represents a big shift in the company’s culture and strategy.  Historically, Microsoft could earn healthy margins by selling their pre-packaged operating systems through retailers, but now the software industry is changing very rapidly.

Managing the costs of such a massive cloud platform could prove to be a challenge to Microsoft.  Data centers aren’t cheap to run and the hosting, cooling, power, and maintenance costs can add up in a hurry.

Including the impact of Skype, Microsoft’s operating expenses for the year will be as much as $29.2B, which is an increase of 2.1% from their previous forecast in October 2011.

Analysts have expressed concerns that shrinking margins could weigh on Microsoft’s results in 2012 if they are unable to manage their cloud computing expenses.

Another two factors that pose a potential risk:  Microsoft recently purchased Skype and they continue to invest aggressively in their Xbox Live platform. While these businesses provide immense strategic value to Microsoft and consumers, both Skype and Xbox weigh on Microsoft’s margins in a big way.

The numbers certainly don’t lie:  In 2011, Microsoft’s profit margins reached a 22-year low and they are poised to drop even further if the company is unable to manage their expenses.

The key challenge for Microsoft in 2012 is to grow their cloud platform while maintaining a laser-focus on managing costs.

Hat Tip to Bloomberg

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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