Office 365 Leads The Return To Profitability For Microsoft Corporation

  • Microsoft’s reporting segments show a clear pattern.
  • The 'productivity and business processes' segment is representative of what the company is trying to achieve.
  • They’ve crossed the first hurdle, and all that remains is a final push into sustainable profitability.

Despite being burdened by a declining Windows business and being caught in the middle of a cloud war against Amazon.com, Inc. (NSDQ:AMZN) and International Business Machines, Corp. (NYSE:IBM), Microsoft Corporation (NSDQ:MSFT) seems to have found a way out of the predicament they’re in. Microsoft CEO Satya Nadella’s imperative of “mobile first, cloud first” is finally getting them some traction in the form of the hugely successful Office 365.

On the consumer side of the business, Office 365 is still seeing 50% growth levels in terms of subscribers. The rate of growth has been so rapid that it has not only displaced Salesforce.com as the No. 1 SaaS (Software-as-a-Service) application in the world, but also created a business that has balanced out revenue decline in volume licensing of standalone Office products.

Microsoft’s Segments

The company essentially bundles its reporting into three key segments: Productivity and Business Processes, Intelligent Cloud and More Personal Computing. The first of these contains Office 365 - both consumer and commercial - as well as Microsoft Dynamics, their CRM solution.

In many ways, this is a showcase segment because it represents what Microsoft is trying to do with its entire business. Nadella’s first port of call is to turn the company around from a potentially loss-making one into a profitable and sustainable business, and this segment is the best case in point an analyst could have.

The declining part of this segment is what I spoke about earlier - lower Office product sales because of mass migration to online, cloud-based solutions. Fortunately, Microsoft themselves have that solution in Office 365, and that’s been validated by large entities like Facebook and the World Bank, both of whom are now users of Microsoft’s SaaS product.

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In the past four quarters, Office 365 revenues have grown by 70%, 70%, 63% and 59% on a constant currency basis. That’s amazing growth for a product that ousted Salesforce.com from first place on the SaaS list just last year.

The Real Agenda Behind Office 365

Of course, Office 365 does bring in enough revenue to show profitability within that segment. The commercial revenue for Office 365 went up by $135 million, and the segment itself grew from $26.43 billion to $26.48 billion. That may not look like much right now, but it shows investors how a declining legacy business is effectively being offset by a relatively new and growing one.

I believe the real agenda behind Office 365 - now that it’s proved its mettle - is to use it as a channel to acquire customers for Microsoft’s other cloud-based services. For example, an enterprise customer who is currently using Office 365 is more likely to open and operate an Azure account or opt in for Microsoft Stream or purchase a Surface Hub and so on.

Your Reason for Investing in MSFT

This is where Microsoft will make real gains. One product leading to another in an endless loop of services offered on the cloud. That is what increases user engagement and customer loyalty, and that is Nadella’s real agenda, in my humble opinion.

More importantly, that is the reason you need to have your money invested in Microsoft now rather than after it becomes solidly profitable once again.

In subsequent articles, I will cover each of their other two segments and draw a parallel with Productivity and Business Processes. They each show different growth trends over the past four quarters, but there’s an underlying thread that runs through the entire business that I will (un)cover in the final edition of this series.

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  • I do not have any business relationship with the companies mentioned in this post.
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