It’s never good news when a major product review site stops recommending an entire product line, but that’s what happened to Microsoft Corporation (NASDAQ:MSFT) when the tech company was taken to task by Consumer Reports for making unreliable laptops and tablets. MSFT stock has been little changed in the wake of the report.
On August 10, the product-rating organization announced that it could no longer recommend any of its portable devices because of reliability issues. MSFT shares have gained less than 1% since then, while the NASDAQ Composite Index has lost an equal amount.
Apparently, investors either don’t care about the news, or they’ve already written off this part of Microsoft’s business. Either way, it’s a sign CEO Satya Nadella might want to consider tossing the entire device market overboard, including its retail store network.
Sure, this might be a radical argument, but if Microsoft is truly going to become the world’s greatest cloud company, it’s not going to do it at the hands of Surface users.
Let’s consider the pros and cons of such a move and what it would mean for MSFT stock.
The Pros: Protect the MSFT Brand
Although it’s often said that there’s no such thing as bad press, Consumer Reports’ latest salvo is more about containing damage to the Microsoft Brand than it is about reliability issues with its laptops and tablets.
Does a reliability problem in one part of Microsoft reflect on the entire organization or is this simply an overreaction on the part of Consumer Reports that will do nothing to change the opinion of Microsoft supporters, both customers and shareholders?
The lack of movement in its stock price suggests it’s the latter.
In the big scheme of things, who cares that they’re unreliable. At product prices far more reasonable than Apple Inc. (NASDAQ:AAPL), customers are willing to put up with the downside. It’s akin to buying a $5 t-shirt at T.J. Maxx. Pay peanuts, get monkeys. It’s part of the bargain.
Still, why bother with this end of the market? Artificial intelligence, the cloud, data analytics, office productivity software — even Xbox Live — are the growth drivers.
Financially, Microsoft’s devices business accounted for approximately $1 billion of the $8.8 billion in revenue generated in Q4 2017 by the More Personal Computing segment which also includes sales from Windows, search advertising, and gaming revenue from Xbox and Xbox Live.
Break it all down, and the Windows and devices businesses accounted for approximately $5.7 billion in revenue in the fourth quarter, a significant portion of which was generated from Windows OEM licensing.
Surface and the rest of its devices, by my estimation, represented less than 5% of Microsoft’s overall Q4 2017 revenue of $23.3 billion.
Is it worth it to potentially harm $22 billion in revenue for the sake of a tablet or notebook? I don’t think so.
The Cons: MSFT is Software AND Hardware
Back in 2015, Nadella made a big splash just 15 months into his job as CEO by firing executives Stephen Elop and Mark Penn and installing Terry Myerson as the head of Microsoft’s Windows and Devices Group (WDG), a sign that hardware was then still essential to the company.
“WDG will drive Windows as a service across devices of all types and build all of our Microsoft devices including Surface, HoloLens, Lumia, Surface Hub, Band and Xbox,” Nadella said in an email to employees. “This enables us to create new categories while generating enthusiasm and demand for Windows broadly.”
The company’s rationale at the time was that its hardware was vital to the Windows user experience because it highlighted how powerful its technology is, providing OEM partners with a primary reason to have Windows 10 in their machines.
“This is a recognition of the new market reality that the OS is part of the device, and the device experience depends on the OS,” Gartner analyst Steve Kleynhans told PC World. “Users no longer distinguish between the device and its operating system so there needs to be close alignment between the hardware and the OS.”
In other words, the hardware and the software go hand in hand.
Bottom Line on MSFT Stock
Although I’m a fan of what Nadella’s doing to transform Microsoft, I recently suggested that despite all the good moves he’s made, he’s severely overpaid.
With this Surface issue looking like it may hang over the company for some time, any delay righting the ship — whether it be selling or spinning off the division including Xbox, or fixing the issues that plague its tablets according to Consumer Reports — is going to slow the progress of MSFT stock.
The company’s making great strides with the commercial cloud finishing the fiscal year with an annualized run rate of $18.9 billion or 22.2% of its overall revenue. That’s amazing considering it was $6.3 billion as of April 2015. It should focus on this area of its business.
Nadella doubled down on hardware but, except for Xbox, it seems in hindsight to have been an abysmal failure.
What Nadella does next is critical to its future success.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.