- Microsoft has cleverly created reporting segments that balance decline with growth.
- More Personal Computing is the one segment that will take some time to show results.
- On the plus side, there are multiple revenue streams that aren’t yet fully realized.
Microsoft Corporation's (NASDAQ:MSFT) sales have declined in the last four quarters with the company reporting annual revenues of $85.32 billion in 2016, down 8.8% compared to $93.58 billion last year. Though the bulk of the difference can be directly attributed to Windows 10 deferred revenues, we cannot deny the fact that Microsoft is in a huge transition phase. They have wriggled out of the feature-phone business, cloud is showing triple-digit growth, selling Windows licenses seems to be a thing of the past, Office 365 is performing exceedingly well and they now have Linkedin to take care of.
Despite the revenue slowdown, Microsoft stock price has surged over the last two years, thanks to the market’s high expectations from CEO Satya Nadella.
He kept the company in the news and at the same time showed growth on several fronts, which was more than enough for the market to overlook the revenue drop. Let’s take a closer look at Microsoft’s 2016 results to see if 2017 will be Microsoft’s year.
Microsoft’s Challenges and Opportunities
Microsoft reports standalone sales numbers for three main segments, Productivity and Business Process, Intelligent Cloud and More Personal Computing. The Productivity segment’s revenue growth was nearly flat for the year and Intelligent cloud grew by 5.5%, while more personal computing sales declined by nearly $3 billion.
More Personal Computing had revenues of $40.46 billion for the year, and this is the segment that accounts for Microsoft's revenues from Windows licensing, search advertising, devices and gaming. What Microsoft has done is to mix its legacy businesses with new and growing segments so they’re pitted against each other.
For example, Office 365 is reported along with Office volume licensing so the growth in the first offsets the decline in the second within the Productivity and Business Processes reporting segment.
They’ve done the same with other segments as well, in such a way that their fast-growing cloud infrastructure business enables their Intelligent Cloud segment to show flat growth rather than negative growth. In More Personal Computing, any revenue decline in volume licensing will be compensated for by future Windows 10 revenues as well as income from new devices and search advertising, as well as gaming.
Gaming is doing well with Xbox Live active users growing from 37 million last year to 49 million at the end of this year. Search advertising revenue has been growing at double-digit rates for the last five quarters, while revenue from Surface devices is showing a steady uptick. But Microsoft does not break out individual numbers and it’s a well known secret that the bulk of the $40.46 billion revenue must have come from steadily declining Windows OEM sales.
The biggest pain point that Microsoft faces now lies in their More Personal Computing segment, as it accounts for the bulk of its revenues.
The Positive Angle
The good news for Microsoft is that PC sales have shown some signs of stability this year and there is a real possibility that we are close to the bottom. But Windows revenues are not going to grow at a stable pace for Microsoft in the future - not even if the company starts offering a monthly subscription for its operating system. We have all gotten used to free operating system on our smart devices, and in this day and age, the possibility of asking a consumer to pay a monthly fee for using an operating system is gone. It may work for Enterprise customers but even there it's going to be an uphill task.
Due to this reason, Microsoft’s Windows revenues will, most likely, keep declining in the next few years and as they go down and Microsoft's other two divisions get bigger, the company should be able to return to a period of stable revenue growth.
Nobody knows how long that is going to take, may be a few quarters or a few years. The advantage with Microsoft, however, is that the company has clearly shown how it is planning to get that done - and it's already working.
As such, Microsoft stock is an extremely attractive investment at this point because of high-potential upsides such as Office 365, Hololens commercial (recently launched) and Windows 10 with the new avatar consisting of the Universal Windows Platform and Xamarin.