- Microsoft took its first big step since a new CEO took over.
- This announcement portends well for the company's future direction and a more collaborative framework for future partnerships.
- Even after the stock's recent run up, the shares look attractive for long-term investors as momentum seems to be turning.
Microsoft's (NASDAQ:MSFT) new CEO, Satya Nadella, announced last week that the software company will make its Office Suite available and compatible with Apple's (NASDAQ:AAPL) iPad. This is the first major announcement that the new CEO has made. It is important for a variety of reasons:
- This starts to divorce Microsoft's software offerings from its Windows operating system. The company has been reluctant to do this in the past and this model worked well when most software was used on PCs where Windows still dominates. It does not work well with the expanding line of mobile devices like smartphones where Windows has a minor market share.
- This means users of iPads will be able to get access and utilize the applications in Office Suite via a ~$100 annual subscription to Office 365. 190mm iPads have been sold since the product was launched in 2010.
- In addition to bolstering revenues, this should accelerate Microsoft's "cloud" efforts. Office 365 revenues ~doubled Y/Y in its last reported quarter and Microsoft had 3.5mm subscribers at the end of the last quarter.
It is this movement to the cloud that I would like to highlight as I think it is critical to Microsoft's future for myriad reasons:
- Cloud represents a crucial source of "recurring billing" as it operates on a yearly subscription. Salesforce (NYSE:CRM) and most cloud plays operate on the same model.
- This enables the company to make minor tweaks more often to its cloud software rather than the huge upgrades it has had to do in the past (Ex, Vista) that have often come to market with a substantial amount of bugs.
- Investors value cloud plays more than regular software firms. As the percentage of cloud revenue rises as part of overall sales, Microsoft should be awarded with a higher multiple. Azure, Microsoft's other cloud offering, is also growing exponentially and is already over the $1B annual sales mark.
- Finally, the cloud is critical in competing in emerging markets. A good case is China where it is estimated that 90% of Office software is actually pirated copy where Microsoft does not get paid a dime. Subscription cloud offerings obviously curtail this piracy as it requires a subscription to work.
Microsoft is now selling at highs not seen in more than a decade. This first major move by the company's new CEO I believe bodes well for future appreciation. It appears Microsoft will be a more collaborative partner going forward which should be conducive to other partnership deals like the one just announced for iPad.
In addition, the shares are still not that expensive. Taking out the company's over $60B in net cash & marketable securities and the shares are priced at under 12x forward earnings, a 25% discount to the overall market multiple (~16x forward earnings). In addition, Microsoft is growing revenues in the 5% to 7% annual range versus the 4% sales gains expected for the S&P 500 in 2014.
The company has a AAA credit rating and pays a 2.8% dividend yield. Another dividend hike should be announced by the end of the year looking at recent historical trends. The stock is not the fire sale bargain it was under $30 a year ago. However, given its valuation and promising direction under a new CEO, I would add to my position on any decent pullback in the market. ACCUMULATE