The Honeymoon Is Over For Satya Nadella

Microsoft's stock is crashing today after the company delivered a middling earnings report and gloomy guidance for the rest of the year. Several analysts downgraded the stock, and it's down more than 9% this morning.

Pretty harsh, considering the company wowed reporters (including me) just last week with its Windows 10 event and the introduction of an augmented reality headset called HoloLens.

So what's going on here?

In August 2013, Steve Ballmer announced his retirement as Microsoft's CEO. Investors were so frustrated with Ballmer's missteps, like whiffing on mobile and spending billions trying to beat Google in search advertising, that they were delighted. The stock is up almost 50% since Ballmer said he was leaving.

Satya Nadella is different from Ballmer. He's technical, not a sales guy. He's got a long-term vision for where tech is going and how Microsoft might capitalize on it. He doesn't seem like he'd ever take ill-advised potshots against new competitive products, like Ballmer did with the iPhone.

But despite Nadella's new tone and some of the changes he's made, Microsoft's business is basically still in the same place it was under Steve Ballmer:

• Most of Microsoft's money comes from big businesses, which are starting to move to lower-margin cloud services. Steve Ballmer's greatest - and often dismissed - achievement was turning Microsoft into a serious enterprise player. In the last quarter, Microsoft got about two-thirds of its gross profit and half its revenue ($10.8 billion and $13.2 billion respectively) from its "commercial" segment - selling to businesses. But revenue from traditional software licensing was down 2%, and Microsoft warned of particularly weak performance in Japan. The big problem: cloud services book less revenue up front than traditional one-time software sales, and have higher ongoing costs. That means as Microsoft's core customers move from buying software to buying online services, Microsoft will face revenue and margin pressure in its most important segment.
• Windows isn't what it used to be. Only 15% of the world's devices now access the Internet using Windows, down from more than 90% a decade ago. This is showing up in various ways: for instance, Windows revenue was down 13% from last year; the end of Windows XP support last year drove a lot of businesses to upgrade, but with that deadline passed, there's less reason to buy new PCs with Windows. Windows 10 will undo some of the missteps of Windows 8, and will be much more appealing to business users. But despite Nadella's new mantra that he wants people to "love" Windows, it's never going to dominate the world like it once did. It will be one of several big important operating systems, not the only one that matters. The collapse of a monopoly business is a long-term margin squeezer.
• Microsoft is nowhere in mobile. After more than four years on the market, Windows Phone has less than 3 percent market share worldwide, and its share has been dropping, not rising. Most developers ignore it. Windows 10 is supposed to change that - it'll be easier for developers to take their Windows applications and revamp them for Windows on phones. But there's very little reason for all but the most devoted Windows developers to do any extra work to target a mobile platform that people aren't buying. Most developers have limited time! They're already busy keeping up with all the changes to Android and iOS.
• Developers no longer need Microsoft. Related to the first point, because Windows no longer dominates, developers no longer have to build for Windows first. They can build for iOS, Android, or the web, and reach more people. Nadella and Microsoft seem to be laying out a long-term vision where Microsoft's platform will not only support Windows devices, but also tie back to cloud services and enable a whole bunch of new types of interactions, like augmented reality (Windows 10 will include a set of APIs for holographs like used in HoloLens). But this is a five-to-ten-year vision. It does little for the next quarter, or next fiscal year.

Nadella is moving Microsoft in the right directions. He understands where the tech landscape is today: people are accessing information from a bunch of devices, not just PCs, and from online services in the cloud, not just computers in their own data centers.

He's no longer putting Windows first - as one analyst quipped to me after the HoloLens demo, it never would have seen the light of day under Ballmer because it doesn't explicitly sell more Windows. Nadella is making smart investments in new business products like Power BI, which promises to let normal people make sense of the flood of data being generated.

But these changes take years. They won't happen overnight. They may fail - Microsoft could keep after mobile (for instance) for another decade and still make no progress.

Yesterday's earnings report reminded Wall Street that it takes time to turn a battleship.