- Microsoft has seen huge growth in revenues from Office 365 and Azure sales.
- The growth of Office 365 will be enhanced by the new subscription based model which allows users to work on multiple devices.
- The rapid growth in the Infrastructure as a service market and low penetration of Office 365 provide Microsoft with an opportunity to grow each of these products into multi-billion revenue streams.
Microsoft (MSFT) has two major growth catalysts: notably, Office 365 and Azure. Assuming Microsoft is able to successfully transition its business to leverage growth in these two categories, Microsoft’s growth rate may in fact accelerate.
Commercial business is booming
When I reviewed conference notes, Microsoft mentions that all the revenue generated by Office 365 has now moved into a new category referred to as “commercial other revenue.” When looking even closer, Office 365 revenue grew more than 100%, and Microsoft Azure grew by 150%. These growth rates look sustainable as Microsoft has relatively low market share in infrastructure- as-a-service (IAAS), and there’s very little penetration when it comes to commercial licenses for Office 365.
According to CNET:
Twenty percent of companies use Azure, while 71 percent go to Amazon for their cloud needs, according to Bloomberg. However, Forrester Research analyst James Staten told the news source that it's possible that Microsoft's market share could grow to 35 percent within the next year.
Also, infrastructure-as-a-service is projected to grow at a fairly high rate, as more and more companies continue to outsource back-end server infrastructure to third parties. According to IDC, IAAS is expected to grow at a 27.2% growth rate over the next five years. The total market size for all cloud related services is expected to be $108 billion by 2017.
These projections are extremely conservative. Furthermore, the market is primarily composed of a few key players, who have generated growth rates above the projected growth for the entire industry. Because of this fact, investor sentiment has heightened. After-all, innovation, lower pricing, and other factors have allowed both Microsoft and Amazon (AMZN) to grow their cloud offerings at a significantly higher rate.
Office 365 early in sales ramp
Microsoft’s business model went from selling licenses to subscription. This doesn’t alter the business by much as it gives the company greater flexibility when pricing Office 365 globally. Because Microsoft can alter pricing to match the proper equilibrium point for different emerging markets, Microsoft can shut-out emerging competition, and continue its edge in productivity software.
Microsoft Office 365 has saturated a small percentage of the market indicating that we’re very early in the sales ramp. Microsoft’s Investors Relation Director, Vikas Mehta states:
Yes, certainly Office 365 has been off to a great start. Our consumer offering Office 365 Home Premium, which we launched over a year back has had a very big success. In just the first 100 days that it reached 1 million subscribers. And now that we have, had a year of the service it has already reached 4.4 million subscribers.
If you think about Office on iPad specifically it has been off to a good start. Since launch just in the first week it had more than 12 million downloads and now we have over 27 million downloads. It has received really very favorable reviews and even on the App Store for iOS which is one if the top downloaded list.
Office 365’s download figure for iOS is different from the total subscriber figure. That’s because each subscription gives consumers a license to use Office 365 on multiple devices.
Pricing of Office 365 ranges from $4 per user per month, to $22 per user per month. However, the total PC market is significantly larger than the total number of current subscribers, and is even bigger than the current Microsoft Office installed base for all versions of Office.
|PC (Desk-Based & Notebook)||341,273||299,342||277,939||268,491|
|Other Ultramobiles (Hybrid and Clamshell)||9,344||17,195||39,636||63,835|
Currently, there are 2.3 billion web capable devices shipped per year. Given the demand for productivity software, Microsoft would only need to convert a small fraction of tablet/desktop/ notebook users to drive topline sales growth in its Office 365 segment. Furthermore, because consumers plan to use multiple devices, Office 365’s license scheme works very well.
Assuming, the revenue per user figures from the Q3 fiscal year 2014 conference call is accurate: Microsoft’s average revenue per user per month is $13. Assuming, Microsoft is able to sell Office 365 to 50% of tablet buyers per year, revenue would grow by more than $13.96 billion.
Microsoft’s penetration rate has been slow. This is because consumers and corporations already own Office licenses. Admittedly the licenses are older, perhaps Microsoft Office 2012, or 2010. Eventually, Microsoft’s current installed base will transition to Office 365, which will contribute to Microsoft’s growth.
Assuming Microsoft can convert a billion users (1/7th the human population) into an Office 365 license, the company would generate $156 billion from a single product category per year. As indicated by the annual PC shipment figure, this is an attainable figure.
Office 365 has the potential to become a $100 billion+ business. Microsoft’s 2013 revenue is $78 billion. Include the growth potential of Microsoft Azure, Skype, Bing, consumer electronics, and future growth prospects haven’t fully priced into the stock.
Microsoft’s topline growth will accelerate as a result of migrating services to the cloud, new product categories, organic growth in existing categories, and future business developments adding to Microsoft's valuation. Furthermore, Microsoft’s software business has extremely high profit margins, giving investors the added benefit of dividend increases, and share buybacks in future years.