For Microsoft, it's virtual reality vs real money

Microsoft earnings on tap
Microsoft earnings on tap   

As Microsoft executives were busy wowing the tech world with holographic goggles that blend the virtual and physical worlds through a futuristic computing platform, investors were busy selling the stock.

The reaction makes sense. At its presentation Wednesday, Microsoft didn't say exactly when the new HoloLens technology will go on sale, and it's way too early to gauge consumer demand. But more important was another announcement from Microsoft on the same day that, at least in the short term, could damage its financials.

Long surviving off lucrative software licenses, Microsoft said that it's giving away free upgrades of its fresh Windows 10 operating system to users of the older stuff. Clearly, Microsoft recognizes that in the new world of software subscriptions and frequent updates, the practice of constantly charging customers no longer works.

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"This is important to rotate customers onto the latest operating system, and serves as a lever to entice developers to build applications for the platform," wrote Colin Gillis, an analyst at BGC Partners, who has a hold rating on the stock and a $49 price target. "That said, a company whose primary business is selling software may have a near term negative impact by providing the product for free."

Of course, Microsoft will still make money from people buying new computers with Windows 10 software, but the PC market isn't growing. In mobile, where Apple and Google dominate, Microsoft's new office programs will be free.

Microsoft reports fiscal second-quarter financials Monday afternoon, and despite the stock's 1 percent sell-off on the day of the big media event, investors are generally bullish. The shares have jumped 31 percent in the past year to $47.18 at Friday's close.

Microsoft unveils HoloLens in Redmond, Washington on Jan. 21, 2015.
Source: Microsoft
Microsoft unveils HoloLens in Redmond, Washington on Jan. 21, 2015.

Chief Executive Officer Satya Nadella, almost a year into his tenure, has boosted the cloud business and partnered with companies big and small to expand its offerings. Analysts expect revenue growth of 7.4 percent in the quarter to $26.3 billion, with a drop in earnings per share to 71 cents from 78 cents, according to a survey by Thomson Reuters.

Microsoft said last week that Windows 10 will be offered as a service but didn't provide specifics around potential subscription pricing. Software as a service, or SaaS, is the new model for delivery and one that Microsoft is being forced to adopt.

"They can't fight the trend," said Sameer Dholakia, CEO of SendGrid, a start-up that sells e-mail infrastructure as a service. "With Satya leading the charge, they're making some bold and sweeping changes required to compete in a mobile and cloud era."

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Microsoft declined to comment ahead of earnings.

Rick Sherlund, an analyst at Nomura Securities, wrote in a report that he expects to hear more about the move to subscriptions on the earnings call.

Sherlund, who has a buy recommendation on the stock and a $56 price target, also called the HoloLens announcement "one of the most fascinating" parts of the briefing.

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Keeping consumers and developers enthused about Microsoft's future is critical in a world where Facebook and Google are investing in virtual reality, Apple is pushing further into wearable computing and dominates cloud infrastructure.

While the demo for the holographic computer lit up social media, it will take time to get investors on board.

"The augmented reality computing platform demo was intriguing, but clearly in the early stages," Sherlund wrote.