- The new Microsoft is going through labor pains right now.
- The transition will take time - and a toll on the stock price.
- What are the emerging growth drivers for the next decade and beyond?
Microsoft (NASDAQ:MSFT) is a company in transition. As revenues from legacy business units decline, Microsoft’s earnings for the past three-quarters have dipped compared to prior periods, and the company is looking at the harsh reality of negative revenue growth this year.
This expectation is clearly reflected in the stock price, which has been trading in a narrow range of $50 to $55 since November 2015.
Will Microsoft manage to claw back up, or is there more downside for the stock? To figure this out, we need to take a closer look at the “new” Microsoft - one that looks radically different from the company it was, only two years ago.
The Signs of Transition
Microsoft has realized its near-utter failure in the mobile phone manufacturing space. After spending $7 billion to buy Nokia, CEO Satya Nadella - who, incidentally, took over after the ink on the Nokia deal had dried - clearly understood that Nokia had no place in a world dominated by iOS and Android. The battle had always been uphill for their own Windows Phone, but in combination with a lackluster brand like Nokia, it was doomed to failure.
The whole purpose of the Nokia acquisition was to leverage a known name in devices to push the agenda for Microsoft’s mobile operating system. At one point they even tried running Android on the devices, but to no success.
So now you have the company looking to divest Nokia’s feature-phone unit but still hang on to the other parts of the business so that the new Windows 10 ecosystem still has a place to live.
The second transition is because of an external force, but equally impactful. That is the decline of personal computers. As PC shipments decline for all the major manufacturers, the Windows maker’s revenues have been edging slowly downwards - to the extent that it has started to hurt their overall revenues.
As you can clearly see, revenue from Windows OEM has been declining at double-digit rates for the last five quarters. With PC shipments not expected to go back to older levels, the optimistic outlook is further losses for Microsoft until that market stabilizes or finds its bottom.
The “New” Microsoft’s Revenue Drivers
Nadella’s new Microsoft has clearly identified its two pillars of revenue growth for the next decade and beyond: Office 365 and Cloud.
Their cloud-based business productivity suite has astonished the likes of Google and even Salesforce.com by becoming the world’s No.1 Software-as-a-Service (SaaS) application today.
But they’re not happy resting on just those laurels. Why do you think they bought LinkedIn for $26 billion? Yes, definitely for their 100 million active users who are all business professionals, but also for a much bigger reason than that - to expose those 100 million to Office 365 in a big way, and to expose their cloud offerings to the chief decision makers numbered in those millions.
Now it makes sense why they would hire a hotshot advertising executive like Eliza Esquivel, doesn’t it? Formerly the VP, Global Brand Strategy, at Mondelez International, which handled a $36 billion portfolio of brands including Oreo and Cadbury, she has recently been brought in to head branding and marketing for Office 365, Outlook and Skype.
And the whole initiative around cloud-based SaaS ties in nicely with their new enterprise hybrid cloud solution, Azure Stack, as well as the cloud infrastructure side offered by Azure.
The Investment Perspective
It all makes sense now: Get Office 365 to the top of its segment, buy the world’s largest network of business professionals, get proven talent like Esquivel to put powerful branding to work, and then top it off with a wide range of cloud services designed to handle the needs of businesses of all sizes - from your local mom and pop shop that wants to go digital, to large enterprise corporations that desperately need to cut IT costs.
On the cloud side, their business has been growing at healthy double-digit rates for the past few years. Though Amazon is the current leader in that segment, Microsoft hasn’t done too badly, either. From a user's perspective, their holistic cloud-based offering looks extremely attractive - all the benefits of the cloud, along with the functionality that they’ve been used to for years.
Despite what seems like an unstable business at this point, looked at from a constant currency angle (CC growth in the table below), you can clearly see where they’re making the biggest gains - Productivity and Business Processes, and Intelligent Cloud.
As such, Cloud and Office products will be the key revenue drivers for the next decade. What we’re seeing right now is that transition from More Personal Computing (legacy products) to the other two reporting segments.
The stock is bound to move down as Microsoft’s earnings decline on a YoY basis, but that’s exactly what you should hope for as an investor. It gives you the opportunity to load up on Microsoft stock while the going is bad. The stock will move up once that transition happens, and with more upside coming in from the Windows 10 initiative to create a cross-platform operating system, a higher share price is definitely on the horizon.