WEEKLY COMPANY INSIGHT: MICROSOFT
Peter Ball, 29 August 2019
Microsoft (MSFT) offers operating system software for computing devices, servers, phones, and other devices (primarily Windows), server application software (Microsoft SQL Server and Visual Studio), cloud services (Azure), business and consumer applications software (Microsoft Office, Dynamics, Outlook, OneDrive, and Skype), software development tools, and Internet and intranet software (Bing search engine, MSN and SharePoint). MSFT also develops mobile phones (Nokia) tablets (Surface) and video game consoles (Xbox) and generates revenue through transactions, subscriptions, and advertising and the sale of first party video games and third-party video game royalties.
Cloud computing focus
MSFT’s new CEO, Satya Nadella, has placed much more emphasis on growing the company’s cloud computing business, Microsoft Azure. MSFT does not break out specific financials for its Azure business and instead discloses it within its Commercial Cloud segment, which includes its other cloud-based services Office 365 and Microsoft Dynamics. MSFT’s Commercial Cloud segment comfortably surpassed management’s target set out in 2014, of US$20bn in annualized revenue by the end of 2018 and revenue shows no sign of slowing.
Significant captive audience
MSFT’s biggest advantage is its ability to leverage off its massive base of enterprise clients. Consulting and business partners, who sell MSFT’s cloud services to their client base, have found that existing MSFT customers have more interest in Microsoft Azure because of their long-term relationship with the company. Given that customers already use MSFT software, the shift to Azure is much easier. MSFT will then be able to up-sell these customers new premium Azure hosted services that can be up and running with a few clicks. MSFT’s other edge over competitors is that it’s already a major software-as-aservice vendor which includes Dynamics, Office 365 and recently acquired LinkedIn.
MSFT’s financial performance has been exceptionally strong over the past 12 months with organic revenue growth of 13% in its latest quarterly result. Five years ago, MSFT was producing organic sales growth of just 1% and a stagnant PC market provided a bleak outlook for Windows revenue. Management’s move into the cloud infrastructure sector in 2013 marked a significant turning point for the company and its revenue growth has accelerated ever since. As revenue growth improved, MSFT was able to maintain its industry leading operating margins, despite a lot of scepticism from investors. Despite the strong move in the share price over the past 12 months, we do not think that the share price reflects the strong broad-based growth across MSFT’s business. Management’s upbeat outlook for 2019 indicates a strong IT spending environment, particularly for its cloud-based services.
- economic slowdown
- regulatory risk
- increased competition