Microsoft’s Microloss?

Microsoft is not in the same dominant position it was in the late 1990′s when it had virtually 100% of the desktop operating system market. Flash forward 20 years to 2012 and Microsoft’s share of the office software suite market has increased but its dominance in the desktop operating system market has not been maintained (see below, it’s roughly 80% with Windows 7 and Windows XP).

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Microsoft has also lost significant market share in other areas, including smartphone operating systems. Do you know anyone that uses a Windows phone? Apparently only 3.8% of us have one.

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Despite these negative shifts in market share, I was a bit surprised to see that Microsoft recently reported a loss of almost $500 million—its first ever loss in 26 years as a publicly traded company. The graph below represents the last 16 quarters (fiscal years 2009 through 2012) of Microsoft’s net income. It’s actually very impressive; despite the loss in Q4 of 2012, Microsoft still earned almost $17 billion dollars in the last twelve months! Why is the loss interesting? Start by realizing that it is the first loss in over 100 quarters (26 years), we should be interested in what triggered or caused the loss. It turns out it is an accounting issue rather than something like plummeting sales of Windows or Office software.

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Back in 2007, Microsoft purchased another company (aQuantive) for roughly $6.3 billion. The intent was to use aQuantive’s technology to help boost Microsoft’s revenue from online advertising (primarily via the Bing search engine). Five years later, management decided that that purchase was not a great use of the money since aQuantive’s technology has not  helped grow revenue as quickly as expected (i.e., not at all). What does this mean from an accounting perspective? In 2007, Microsoft purchased an asset (all the shares of aQuantive)for $6.3 billion. In 2012, management did an assessment of that asset and determined that it was essentially worthless. Accounting requires that we write down worthless assets, so Microsoft expensed the entire value. The journal entry would be:

CR Long Term Investment in aQuantive [Asset]  $6.3 billion

DR Asset impairment expense [Expense]  $6.3 billion

Therefore, net income is decreased by the full $6.3 billion, resulting in an overall loss for the quarter of $492 million.

Some people argue that this is a temporary blip; Microsoft is still generating approximately $6 billion of income per quarter before write downs like the aQuantive one. In fact, the stock market reacted positively to the earnings release, so obviously shareholders weren’t too upset by the loss.

On the flip side, however, I believe that the write down suggests that either Microsoft made a fairly large investment ($6.3 billion!) in something that turned out to be worthless (in which case, shame on them!), or their business model, particularly online advertising revenue, is suffering substantially.

It’s too early to determine if this loss will have repercussions for Microsoft, but I will be keeping my eyes and ears open and post anything else related to this matter.

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