Microsoft deal talk overshadows results

By Bill Rigby

SEATTLE (Reuters) - Microsoft (MSFT.O) will likely report the first annual sales dip in its history as a public company, but investors are looking beyond that for upbeat comments on Windows 7, signs of a tech sector recovery, and even a deal with Yahoo (YHOO.O) to challenge Google (GOOG.O).

The question for investors when the world's largest software company reports quarterly results on Thursday is whether it can present enough optimism to maintain the momentum that has pushed shares up 63 percent since early March.

Tech heavyweights IBM (IBM.N) and Intel (INTC.O) ratcheted up expectations last week by blowing through Wall Street forecasts and setting ambitious outlooks that suggest the worst may be over for the sagging computer business.

Microsoft, whose software drives more than 90 percent of the world's PCs, stands to benefit as it prepares to roll out its new Windows 7 operating system in October.

"There's been a sentiment shift," said Todd Lowenstein, a portfolio manager at HighMark Capital management. "People are starting to get excited now about the visibility of Windows 7 -- it's got good reviews and they've got some pent-up demand."

"They've turned the corner in a lot of their businesses," said Lowenstein, a manager of HighMark's Value Momentum mutual fund, which holds about 530,000 Microsoft shares.

Aside from Windows 7 -- which should help erase bad memories of its poorly received predecessor Vista -- Microsoft has a new version of its huge-selling Office suite of applications in the works, and it is finally making headway against Google with its six-week old Bing search engine.

After months of intermittent negotiations, and an aborted takeover bid last year, Microsoft finally looks ready to strike an Internet search and online advertising deal with Yahoo, according to a source familiar with the situation. An announcement could come before the results on Thursday.