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Should Microsoft Dump Bing? Not on the Strength of This Argument

Time for Microsoft (MSFT) to dump its money-losing Bing search engine, argue journalists Robert Cyran and Martin Hutchinson at Reuters BreakingViews. As a distant second to Google (GOOG) that drags down Microsoft earnings, Bing shouldn't stick around, they argue. Surely a "sale would be a boon for Microsoft's investors."

Novel ideal. Unfortunately, the logic is questionable and the writers make assumptions based on data that doesn't say what they think it does. Maybe management at Microsoft is completely stupid, ego-driven, and wasting billions a year in a quixotic chance for online relevance. Then again, maybe there's something else entirely going on that the two writers have missed.

Reductio ad assumption
Here's their argument:

  1. Microsoft keeps pouring money into Bing, and the division that houses it lost $2.6 billion last year.
  2. Bing-powered search is only about 27 percent of the U.S. market.
  3. Advertisers want choice in search services, which should assure future revenue.
  4. A reasonable value for Bing would be $11 billion, based on Google's value being six times its sales with a 25 percent discount and the $2.5 billion in revenue last year from Microsoft's online services unit, "of which Bing is the main component."
  5. Facebook, or maybe Apple (AAPL), would be interested in buying Bing.
  6. Microsoft could take either cash or stock and provide value to its shareholders, while reducing a major center of loss.
An argument is only as good as the assumptions on which it rests. In this case, they are dubious. The dollar figures the two throw about come from Microsoft's reporting of its results for the fiscal year that ended in June 2011 (click to enlarge):

At first glance, the $2.6 billion loss and $2.5 billion revenue numbers look correct, as they are reported under U.S. GAAP, the recognized standard in this country. But GAAP is a convention with rules of how to treat revenue and expenses that can be confusing, counterintuitive, and sometimes even misleading.

Follow the money

For example, the GAAP numbers for online services in Microsoft's earnings release for FY2010 show revenue of $2.2 billion and an operating loss of $2.36 billion. However, instead of using GAAP, the 2010 annual report looks at the divisions the way Microsoft management does:

Due to the integrated structure of our business, certain costs incurred by one segment may benefit other segments. The costs that are identifiable are allocated to the segments that benefit to incent cross-collaboration among our segments so that one segment is not solely burdened by the cost of a mutually beneficial activity. Each allocation is measured differently based on the specific facts and circumstances of the costs being allocated. These cost allocations were not material in any period presented.
In other words, GAAP doesn't accurately show how the divisions interact. In this other view of divisional revenue and income, online services still brought in $2.2 billion. The loss, however, was $2.44 billion -- higher than under GAAP. And Microsoft makes periodic significant shifts in divisional structure. There is no way to know for 2011 what costs online services might effectively bear for other divisions.

In the face of this tangle, to claim that Bing is the main component of online services is impossible to justify. Here's how Microsoft defines the group in its last earnings release:

Online Services Division ("OSD") develops and markets information and content designed to help people simplify tasks and make more informed decisions online, and that help advertisers connect with audiences. OSD offerings include Bing, MSN, adCenter, and advertiser tools. Bing and MSN generate revenue through the sale of search and display advertising. Search and display advertising generally accounts for over 85% of OSD's annual revenue.
The combination of search and display advertising is 85 percent of the annual revenue. But is that all Bing? Hardly. According to comScore, Microsoft sites are the third most-trafficked in the U.S. Look at the ad rankings and you see that Bing had an estimated 45.7 percent of the domestic Internet audience, while MSN had 56.8 percent and Microsoft's Media Network US had 65.9 percent.

There is no way that the authors can reasonably assume that Bing represents most of the revenues, costs, and loss for the division. Unless they have inside information from Microsoft, the entire analysis is fundamentally flawed because they can't untangle Bing from the online service division, let alone from the rest of the company.

Search share shenanigans

The logic that follows the assumptions is even more flawed. The writers want to dismiss Bing because the search engines it powers have only 27 percent of the U.S. market. Think about that for a moment -- more than a quarter of the entire U.S. search market. Even if Google holds more than twice as much, that's a significant chunk of business.

The 27 percent U.S. search market share number that the writers mentioned came from Microsoft, except Microsoft didn't qualify it as U.S. search, so they added that. Depending on which source you use, Microsoft's share could be even higher.

For example, in its April search results report, comScore put Microsoft and Yahoo's combined U.S. share at 29.6 percent. Experian Hitwise put Microsoft at a 30 percent share in March 2011.

On one hand, Microsoft is wasting money. On the other, Bing's inherent value is $11 billion. If it's worth all that much, particularly because of the future revenue it can generate, is it really a waste?

And about those "potential buyers"...
Furthermore, Microsoft can sell Bing, they assert, because "there are potential buyers" like Facebook, which leads the nebulous pack because it already works with Bing and "might be interested in buying the site." It's a classic case of begging the question, in which the deductions are used to prove the initial assumption.

The two say that Facebook could "perhaps [use] its data to better tweak search results." Did they ever look at how badly targeted a lot of Facebook ads are? And if Facebook has a partnership with Microsoft, which already owns more than 1 percent of the social network, doesn't Microsoft have a partnership with Facebook? And if the engine were that valuable to a Facebook or Apple, why wouldn't it be to Microsoft?

Finally, Cyran and Hutchinson argue that getting rid of Bing would end large losses in the online division. But since they don't really know how much of the revenue and losses are attributable to Bing, they're talking out of their hats. They also ignore Microsoft's penchant for long-term investing and development. At one time, Xbox looked like an utter loser of a business line. Now, it helps offset the drop in Windows revenue and profit.

This is one seriously bad piece of analysis. Nonetheless, it will get a lot of play because it paints Microsoft in a bad light. But seriously, folks -- if you're going to take pot shots, at least make sure the gun is loaded.


Image: Flickr user Falashad, CC 2.0.