Microsoft sees play as profit center

. – When Microsoft Corp. makes its annual presentation to investors and analysts here today, executives will be preaching the value of patience to stockholders who are nervous about the world’s largest software company’s online prospects.

Executives plan to hold up the entertainment and devices division – home of the Xbox game console, Zune media player and cellphone software – as a prime example of persistence rewarded.

After investing $6 billion since the introduction of Xbox in 2000, the division last week finally reported an annual operating profit, $426 million, aided by the blockbuster release of Halo 3.

“The credibility of entertainment and devices has now been established without question,” division President Robbie Bach said in an interview. “We want people to say, ‘They’ve got a strategy, they’ve grown. Microsoft has a serious play in the consumer space.’ ”

There won’t be such talk around Microsoft’s online services business. Last week, the company announced plans to invest up to $500 million more into the money-losing division during the just-started fiscal year, adding to a sense of alarm created by the thus-far-unsuccessful attempt to buy Yahoo Inc. or its Internet search business.

Highlighting its struggles, Microsoft said Wednesday that Kevin Johnson, the executive who led its bid for Yahoo as president of platforms and services, was leaving the company. A person familiar with the matter said Johnson would become chief executive of Juniper Networks Inc., which could not be reached for comment.

Microsoft said the division Johnson ran would be split in two: Windows/Windows Live and online services.

“They are trying to catch a runaway freight train,” Citigroup analyst Brent Thill said of Microsoft’s pursuit of Google Inc. in the market for online advertising. “They are laying tracks, and Yahoo has tracks laid too. Now that the likelihood of buying Yahoo has dropped, they’re back at square one.”

Microsoft’s stock has fallen by more than a quarter this year, despite strong earnings growth, partly because of such concerns about the future. Facing what analysts predict will be the toughest questioning in years, Microsoft Chief Executive Steve Ballmer and other leaders today will point to the company’s history of investing heavily over a period of years before hitting a big payoff.

That’s what happened with Microsoft’s effort to sell high-end software to big companies. The related division threw off $4.6 billion in operating income in the fiscal year ended June 30, behind only the twin pillars of Windows and Office.

But even as Google and others start to offer traditional software functions as a service over the Internet, many analysts take Microsoft’s ability to sell to businesses for granted. They worry more about Microsoft’s relationship with consumers, where the company lacks the devotion kindled by Apple Inc., Google and even Yahoo.

For that reason, Microsoft will be talking a lot about digital entertainment.

The company is now a major player, along with Nintendo Co. and Sony Corp., in the $40-billion video game business.

The Xbox Live online game service has been key. Nintendo and Sony offer online options for their consoles, but Microsoft’s is more developed.

Since launching its on-demand service for renting movies and buying TV shows last year, Microsoft has amassed more than 20,000 hours of video, making itself into one of the country’s top 10 purveyors of on-demand shows. Half of that came from a deal announced last week with Netflix Inc. to supply subscribers with a catalog of movies that can be streamed directly to the television.

At the annual E3 gaming conference last week, executives said Xbox Live customers had spent more than $1 billion on $50 annual subscription fees and downloads of movies, shows and games.

Microsoft counts 12 million Xbox Live users, many of whom play for hours each day. Don Mattrick, executive vice president for Microsoft’s interactive entertainment business, said the service demonstrates how Microsoft can transition from a seller of packaged software to providing a platform for all manner of digital sales.

“It’s a wonderful case study of how we can provide a service and scale it to millions of users,” Mattrick said. “You’ll hear this as a common theme at Microsoft.”

By becoming a part of millions of living room entertainment systems, the Xbox business succeeded where other Microsoft efforts failed. According to researcher NPD Group, Microsoft has sold 10.5 million Xbox 360 consoles in the U.S. since launching the device in November 2005.

More than half of those consoles are hooked to the Internet, giving the company a potentially valuable portal into consumers’ homes.

For now, however, Xbox users are primarily males between the ages of 15 and 34. Microsoft has not yet captured the mainstream consumer in the same way its rival Nintendo has with the Wii console.

Microsoft tried to address that last week by unveiling a friendlier user interface for its online service and by adding games that anyone can play, including karaoke and trivia titles.

The company also hasn’t articulated a strategy for enabling consumers to take their content with them without hauling around their consoles. Sony, which announced its long-awaited movie download service for the PlayStation 3, lets customers transfer their movies or shows to the PSP, Sony’s hand-held console.

Microsoft aims to break even on the costs of the console, earning money on the games instead. To really break into the broader market, though, it needs to sell a console for less than $200, where more than 75% of hardware sales occur. Microsoft currently sells its Xbox 360 for about $280 to $400, depending on the size of the hard drive.

Bach said that although he will eventually get to $200, there’s no rush. “Right now, we have strong demand at the price we’re at,” he said.

Analysts appreciate Microsoft’s expanded access to consumer living rooms and the potential for bigger profit down the road.

But they say that as impressive as the entertainment division has been in staving off Sony and Nintendo, it hasn’t performed a miracle, and it isn’t a reliable guide for what will happen with online search and advertising.

In search, Microsoft is a distant No. 3 behind Yahoo, which is a distant No. 2 behind Google.

“It’s like this never-ending, vicious spin cycle,” Thill said of Microsoft’s online campaign. “They just can’t seem to snap out of it and have some clear direction.”

 joseph.menn@latimes.com

 alex.pham@latimes.com