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Summary

  • Tim Cook has just been given one of the best gifts as CEO.
  • A year from now, investors may wonder, "what in the heck was Nadella thinking?" And so will Ballmer.
  • Microsoft's "generosity" to Apple might be a double-edged sword.

With Microsoft (NASDAQ:MSFT) stock trading at near 52-week highs, no one is using the term "Mr. Softy" anymore to describe the company's performance. It's true that Microsoft is no longer the playground bully that it was in the late 1990s. But the company is far from the pushover it resembled under Steve Ballmer. That said, although the stock is trading much better these days, Microsoft is not back to full strength. And we worry that investors are getting ahead of themselves.

The stock has been boosted by (surprisingly) Apple (NASDAQ:AAPL). The word is that Microsoft new CEO Satya Nadella plans to make Microsoft Office available to Apple's iPad next week. We see this as a good move, especially since former CEO Steve Ballmer was adamantly against the idea. The notion of putting Microsoft's enterprise software on an iPad made Ballmer cringe. But analysts are applauding Nadella's decision.

On the rumor of next week's launch, Ross MacMillan of Jefferies raised his earnings estimates and price target for Microsoft. While keeping his "buy" rating on shares, MacMillan raised his price target to $47 from $42. MacMillan believes that moving Office to the world's best-selling tablet could be bigger than originally estimated. In his research note, MacMillan said:

"Our updated analysis suggests that O365 could be a bigger driver than we previously assumed," MacMillan wrote in the note. "We now think native Office for iPad (available through an O365 subscription) could drive $2-4 incremental value per share predominantly from the consumer market."

The risk here is that Microsoft's "generosity" to Apple might be a double-edged sword. There's no question opening Office 356 to Apple's iPads will boost Microsoft's bottom line. But Apple's lack of enterprise applications for the iPad has been one of the company's main weaknesses. The other factor is, Apple has made it known that it is "not a hardware company."

Although Apple continues to post strong results for the iPhone and its Mac line of hardware, CEO Tim Cook has worked to steer Apple into more of a software/services company. These areas are known to offer stronger profit margins. Not to mention, analysts are more willing to apply more "generous" valuation multiples to these companies on the assumption that they will repay investors with larger profits.

The news regarding Office 365 is expected to be announced in San Francisco next week on March 27. It certainly seems as if a new Microsoft has emerged. But again, Apple may use this as a Trojan horse (of sorts). Not to the extent of harming Microsoft per se, but Office on the iPad just made the iPad more sticky and relevant.

If given the choice, it would seem, according to revenue data, that enterprise users would choose iPads over Microsoft's Surface. So what leverage will Microsoft have left? For Apple, Tim Cook has just been given one of the best gifts as CEO. He's possibly weakening a competitor, while at the same time appearing prophetic, given his past statements regarding Apple's inroads in software and services.

Last quarter Apple posted 20% year-over-year growth in its software business. The company generated more than $4 billion in sales. Now with Microsoft's dominant Office application, Apple could possibly boost this revenue by close to $6 billion next year. This suggests close to 40% growth. This is assuming that the standard 30% rate that Apple earns on software purchases remains.

And even if, say, Apple's software revenue grew incrementally by 5% next year, this still presents $5.5 billion in revenue. Even more impressive, this will occur at an extraordinarily attractive profit margin. So, as it stands, we see more benefit to Apple than we do for Microsoft. And this is being very generous.

Microsoft bulls may disagree about this statement. And we certainly won't know for (at least) a full year after this launch who got the better end of this deal. For now, I'm willing to applaud the company for its efforts with Office 365 and for thinking outside the box. But a year from now, investors may wonder "what in the heck was Nadella thinking?" And so will Ballmer.

Source: Microsoft Just Killed Itself, Apple Wins Again