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Friday, April 28, 2006 - Page updated at 12:00 AM

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Building a Google? Microsoft pouring cash into Web fight

Seattle Times technology reporter

Microsoft is supercharging its business in the coming year with a spending burst that made some Wall Street analysts do a double take Thursday.

The company plans to plow perhaps $2 billion more than expected — a meaningful sum even for the world's largest software company — into new technologies, marketing for its most significant wave of product launches in a decade, and the fight for online supremacy against Yahoo! and Google.

The spending projected for Microsoft's 2007 fiscal year is estimated by some analysts at about $20 billion or more. Paired with recent news of heavy capital investments in huge digital warehouses to store data, it looked to one veteran analyst like the company was trying to replicate its chief online rivals.

"It sounds like you're building a Google or building a Yahoo! inside the company," Rick Sherlund, senior analyst at Goldman Sachs, said during Microsoft's conference call to announce its quarterly financial results Thursday.

Chief Financial Officer Chris Liddell said Microsoft plans to spend big on growing businesses such as Internet search and online advertising, where it is trailing the competition. But it's also investing on a dozen other fronts, including making the most of the early start Xbox 360 holds over Sony in the video-game market and preparing to launch new versions of its core products, Windows Vista and Office 12, both due out in the next nine months.

"Today, we believe we face the largest array of opportunities for growth and innovation the company has ever seen," Liddell said.

The increased spending already was reflected in Microsoft's financial results for its third fiscal quarter, which ended March 31. The company reported $10.9 billion in sales, in line with its previous forecasts. Operating income was $3.89 billion, up 17 percent from the year-ago period but 13.5 percent below Microsoft's forecast. Net profit, which accounts for other expenses, including legal costs, was $2.98 billion, compared with $2.56 billion a year ago.

Liddell said the company's increased investment would be reflected in the fourth quarter, as well.

Greater investment at Microsoft means more hiring. The company's head count increased 15 percent in the past year, although it did not provide current employment figures. Last fall, it reported 63,564 employees worldwide, 30,255 of them in the Puget Sound area.

Specifically, Liddell said the company will be adding to its sales force to support the new products.

But the increased investment, 10 percent over Sherlund's expectations, also means skimpier returns for investors in the short term.

"We are willing to make those trade-offs and believe that we have a unique opportunity at this part of the product cycle to drive substantial long-term growth," Liddell said.

Investors were expecting the coming launches of Vista and Office — the first time since 1995 that new versions of these two flagship products have been rolled out together — to ramp up shareholder returns and perhaps lift the company's long-stagnant stock.

Wall Street forecasters expected earnings of $1.53 a share for the 2007 fiscal year, well above Microsoft's forecast of $1.36 to $1.41 a share.

"It's bad to surprise the Street," Sherlund said. "It's harmful to the stock because investors are looking for the rewards of this big product cycle next year flowing through to earnings."

That was reflected in after-hours trading Thursday, during which Microsoft shares lost $1.75, or 6.4 percent, to close at $25.50. In regular trading, Microsoft had closed at $27.25, up 15 cents.

Liddell countered Sherlund's suggestion that the spending increase, which concerned several other analysts as well, was focused on a large, unknown project in online services. "I don't think there's any Trojan horse there that we haven't talked about," Liddell said.

Some analysts said Microsoft might be holding its cards close to the vest.

"They may have strategies they don't want us to know about," said Brendan Barnicle, an analyst at Pacific Crest Securities in Portland. "Maybe they're right, but they've created uncertainty around these expenses."

The online business is clearly of huge and growing importance to Microsoft.

Chief Technical Officer Ray Ozzie, brought on board a year ago with the acquisition of Groove Networks, wrote one of the company's famous internal memos last fall signaling a major change of direction toward providing services over the Internet.

A few days later, Microsoft Chairman Bill Gates outlined the company's "Live Software" strategy, in which basic software functions are delivered over the Web as a service, rather than residing on a user's computer. Microsoft is rolling out more Live products all the time.

In an interview with Fortune magazine earlier this month, Ozzie outlined some specifics, such as Live Drive, an online system that could augment or replace computer hard drives for storage of documents, photos and music.

To make it happen, Microsoft will need to build so-called server farms, like one on the way in Quincy, Grant County. It will have three buildings totaling 1.4 million square feet, packed with computers to store all that data and make it available to individuals via the Internet.

Those capable of laying the building blocks on a massive scale "are companies that have both the will and the capacity to invest staggering amounts of money — staggering amounts," Ozzie told Fortune.

Clearly, the competition is fierce. Google sought to raise $2.07 billion with a stock sale announced last month.

Asked if he thought Microsoft's spending in 2007 would be focused on an answer for Google, Barnicle said, "If they're not and they're just spending all this money, it just seems like the operating leverage of this company has declined a lot."

Liddell said Microsoft will spend more to meet and drive consumer demand for the Xbox 360. The game console got off to a rocky start after its November debut, and there were shortages during the holiday shopping season. Microsoft has an advantage over competitor Sony, which won't release its next-generation video-game console until November.

Microsoft is also pushing its software into more mobile phones and expects that segment of its business to grow 15 to 25 percent in the fourth quarter, driven by new devices running on the Windows Mobile 5.0 operating system.

Microsoft CEO Steve Ballmer told the wireless industry at a conference earlier this year in Barcelona, Spain, that he spends "more time meeting with telecom executives these days than I do with any other segment."

Benjamin J. Romano: bromano@seattletimes.com. Seattle Times senior technology writer Brier Dudley contributed to this report.

Copyright © 2006 The Seattle Times Company

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