Goldman to Microsoft: You're Better than This, Redmond

Goldman Sachs gives Microsoft tough love in a report, suggesting the company carve out its consumer business to survive.

Investment banking and securities firm Goldman Sachs let Microsoft have it in a financial report yesterday that downgraded the company from a "buy" to a "neutral."

The report, written by Goldman Sachs analyst Sarah Friar and associates, states that in the two years Microsoft has been on the Americas Buy list, its shares have "returned -13 percent, compared to -11 percent for the S&P 500." Goldman also states in the report that it has lowered Microsoft's earnings estimates for the current fiscal year by 4 percent, and dropped its price target for the stock from $32 to $28.

Why is Microsoft slipping so much in Goldman's eyes? The firm pounces on some obvious weak areas in Microsoft's portfolio such as mobile, tablet PCs and a counter-productive strategy of having one company serve both businesses and consumers.

One thing's clear from Goldman's end: Microsoft needs to change. "We believe the intrinsic value of shares cannot be unlocked if the status quo remains," the report states.

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Two of the big ways Microsoft can "unlock value" is to clarify its consumer strategy and become the market leader in cloud computing. Goldman states that Microsoft is on its way to be a successful cloud player with its portfolio of data center assets, but is "still not a clear winner."

One market that Goldman thinks Microsoft should definitely lose sleep over is mobile, where the company must be immediately successful to restore credibility.

To Microsoft's credit, it has poured an estimated $500 million into the development and marketing of Windows Phone 7. Microsoft is hosting an event in New York City to launch phones on Oct.11. But the phones will be entering a smartphone market swarming with established players like BlackBerry, the iPhone and Droid phones. It doesn't take a Goldman Sachs' warning to remind everybody how important this is for Microsoft.

Another troubling subject for Microsoft highlighted in the Goldman report is that big enterprises have become more cautious about buying new PCs as the economy continues to falter. A CIO survey conducted by Goldman concluded that an expected delay in PC upgrades will hurt Windows software sales this year. The same survey states that the tablet PC market, where Microsoft has hardly any presence and Apple's iPad dominates, will soon cut into sales of Windows notebooks.

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Goldman's big, bold recommendation to "unlock hidden value" is to break out the consumer side of the company to keep it from being overshadowed by the more profitable enterprise side. Microsoft has resisted this strategy in the past but Goldman cites that it has worked for rivals and urges Microsoft to try.

"To date Microsoft's comments suggest that management still sees significant value in combining the consumer and enterprise efforts, but we view a foot in both camps as preventing a successful focus on one strategy, a la Oracle in the enterprise or Apple for consumers."

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