Microsoft's Online Business and Strategy in Its Own Words

Here are the key quotes from Microsoft's (MSFT)conference call about its Internet business. The last section, in which Microsoft lays out its search and online advertising strategy, is long -- but contains crucial information for anyone following any Internet stocks:

1. Online revenue in Q2

Online services business grew revenue 24% to $838 million. Online advertising grew 18%, including $33 million of ad revenue from aQuantive. While both search queries and page views were up and in line with expectations, monetization lagged, driven by tightening advertising budgets combined with a more competitive display pricing environment. We continued to attract users to our properties with live IDs hitting 460 million, up 80 million from last year. And we grew the number of advertisers utilizing our advertising platform by 28% during the year.

2. New initiatives and acquisitions

We closed the acquisitions of FairCast, which offers technology to aid in the purchase of online tickets at the lowest price, and Navic Networks, which develops tools to deliver targeted ads to television set-top boxes.

In May, we announced the beta launch of Live Search Cashback. Since then, we have 680 merchants participating in the program with about 200,000 registered users.

3. Guidance for Q3

...We forecast revenue in the online services business to increase 18% to 20% for the year, and 7% to 11% for the first quarter. The advertising component of revenue is expected to grow at approximately 25% for the year and 15% for the quarter.

Our Q1 guidance assumes the continuation of the challenging online advertising market experienced in the fourth quarter. We expect revenue growth will accelerate through the year as we begin seeing returns from the additional investments we are making in the business.

4. Online growth strategy

Clearly the online services business has a totally different dynamic and is in a period of significant investment. We do not make these investments lightly, as the loss in this division will be a drag on an otherwise exceptionally good performance.

However, we believe that the additional investments of several hundreds of millions of dollars is worth the short-term cost, given the opportunity to participate in a market where the opportunity is measured in the tens of billions of dollars.

So I wanted on the call to take a few minutes to frame our reasoning behind the additional online service business investments. I will start with an overview of our broad strategy and then provide details into the additional investments.

With the online ad spending expected to reach $80 billion by 2012, this area represents one of the largest growth opportunities for the company. We segment the market for online advertising in four distinct categories -- search, advertising platforms, information content, and communication and social networking.

For search, we’re focused on driving query share improvements and business model innovation, specifically in the area of high value commercial search. Our recent release of Cashback is a good example of executing on our strategy, which combines innovation in the shopping experience with a shift in the distribution of advertiser economic towards the end users.

Additionally, we also [seek to win] targeted distribution through OEMs, ISPs, ISVs, and retailers. The recently announced deal with HP in the U.S. is an example of [this].

Turning to the ad platform, our strategy can be summarized as consolidate [when in] display, and there we are focused on integrating our advertising assets into a single comprehensive system that can deliver our publishing partners’ industry leading yields and our advertisers optimal return on their ad spend.

In the area of communication and social networking, which includes our mail, messenger, and social networking assets, such as Spaces, we’ll deliver the leading end-to-end experiences across the PC, phone, and web.

And finally, in the category of information content, we plan to invigorate our MSN portal experience with improvements in user experience, social media consumption, and premium content.

As well as overall advertising revenue, which is clearly the overall measure of success, we have aggressive growth targets in each of the above areas over the next five to 10 years. These targets can be broken down in terms of the percentage of share of worldwide page views, percentage of share of Internet [inaudible], the percentage share of search queries, and percentage of the growth of the online advertising dollars that pass through our platform.

Clearly the Yahoo! transaction, which I’ll make some more comments on later, would have accelerated our progress towards these goals. However, during the quarter, a transaction became increasingly unlikely. Further, as you know, during the quarter Yahoo! signed a search outsourcing agreement with Google. Given that environment, we made some decisions to accelerate our online services’ organic growth strategy. Mainly we decided to increase our investment in the high-margin scalable areas of search and ad platforms.

So about two-thirds of the incremental spend that we are planning is related to investments to drive usage of our search offering. We’re dialing up our search distribution initiatives with targeted OEM toolbar [alt] search deals, scaling search globally with investments in localized engineering and data centers, pursuing acquisitions and partnerships to build vertical content to support our commercial strategy, accelerating the rollout of our Cashback program, and increasing marketing in the business to grow awareness and drive traffic.

Second, we are upping the investments in our ad platform and increasing the number of advertisers and high quality inventory on that platform. Specifically, these investments are in the area of accelerating the integration of our ad platform assets, expanding our sales and service capabilities, small acquisitions to enhance the platform technology, and investments in strategic partnerships to increase third-party inventory available to advertisers on our ad platform.

The quotes are taken from the full Microsoft transcript which was published on Seeking Alpha a few hours after the call ended.

Also of interest -- here are all the transcripts from the Internet sector.