What Is Satya Nadella's Plan For Microsoft

May. 2.14 | About: Microsoft Corporation (MSFT)

Summary

The new CEO, Satya Nadella, came up with a new vision that he calls the “mobile first, cloud first world."

Microsoft’s stock has gone up 19% since long-time CEO Steve Ballmer announced his plan to retire last August.

Third quarter revenues were in line with analysts’ expectation and there was good momentum in a number of business segments.

Microsoft Corporation's (NASDAQ:MSFT) new CEO Satya Nadella recently participated in his first earnings call with analysts. Under Satya Nadella's leadership, the big software giant posted strong third quarter results as evidence of his sensible direction as the new CEO of Microsoft. He has expanded on his theory of focusing on mobile and internet-centric computing which he says are necessary in what he calls the "mobile-first, cloud-first world." To bring his vision into reality, Nadella has already introduced Microsoft's popular Office software for Apple's iPad and opted to give away Windows to makers of small-screen mobile devices. These moves show that Nadella wants Microsoft's services to be widely available without being tethered to the Windows operating system.

When talking about first mobility, Nadella explained, "It's about offering users a great experience across devices, some ours, some not ours, that we can power uniquely." For the cloud, Nadella is committed to the ongoing mission of one cloud for everyone and for every device. Microsoft's new strategy to move into a different dimension of the tech market and working with other platforms is what was missing in the company's previous vision. The change of leadership is favoring the company as Microsoft stock has gone up 19% since long-time CEO Steve Ballmer announced his plan to retire last August. Nadella's introduction as CEO and some important initiatives have caused the stock to go up 8%. Its shares rose almost 3% in after-hours trading to $40.96 after the announcement pushing the stock to levels that it has not seen since the Internet stock boom.

Progress

In the recent third quarter, Microsoft's revenues were in line with consensus estimates but the earnings results were higher than expected. Overall, the growth was a result of an increase in sales of Windows OS to businesses, significant momentum in the development of cloud services, and effective cost control. For the quarter, Microsoft generated $20.4 billion in revenues, which is what analysts were expecting but there were also a few significant improvements in a couple of business areas that can be considered key growth drivers for the future. For the quarter, Microsoft reported earnings per share of $0.68, beating analysts' earnings per share estimate of $0.63.

The device and consumer and commercial segments' revenues grew 12% and 7% to $8.3 billion and $12.23 billion, respectively. Overall, the company's growth has been decent given the secular decline in PC shipments. By all intents and purposes, the PC industry has hit rock bottom and the chances of any growth are thin as consumers continue the shift to mobile devices.

Microsoft's device and consumer segment includes sales of Xbox consoles, Surface tablets and Windows OS for PCs. Revenues from Windows sales to original equipment manufacturers (OEMs) grew 4% to $4.38 billion, topping analysts' estimates of $4.2 billion. Xbox sales were recorded at $2 million for the quarter with the Xbox One accounting for $1.2 million. Surface tablet sales grew 50% to $500 million.

Office 365 Home added one million subscribers in the quarter to total 4.4 million. Recently, Microsoft also unveiled its Office suite for the iPad. Though the suite was in development before Nadella became the CEO the quick roll-out has been to his advantage.

Microsoft ended support for Windows XP and this is in Microsoft's favor as the company's revenues from Windows increased during the quarter. Apart from the rapid transition, causing a slower than expected decline in PC shipment during the first three months of 2014, 28% of PCs are still running Windows XP and when these operating systems are replaced Microsoft will reap the benefits.

Previously Microsoft was missing an opportunity but recently it offered its Office suite for iPad users. Apple's (NASDAQ:AAPL) iPad dominates the tablet market and its sales increased from 32.4 billion units in 2011 to more than 70 billion units in 2013. The number of iPads in use should be even higher and if on average an iPad is used three years then there should be around 190 million iPads in use. The subscription pricing is $6.99 per month or $69.99 per year and the business premium subscription pricing is $12.50 per month or $150 per year. Obviously, not all iPad users will use the Microsoft Office app and even if they download it not all of them will pay for the subscription. Even if one-third of total users opt for the subscription plan Microsoft is likely to enjoy enough earnings.

Microsoft's Outlook is Compelling

Microsoft provided conservative revenue guidance and expects revenues in the range of $20.4 billion to $21 billion, slightly below consensus estimates of $21.04 billion. Within the devices and consumer segment the company expects $4.1 to $4.3 billion in revenues from licensing assuming a moderate impact from Windows XP support termination. In devices and consumer hardware revenues are projected to be in the range of $1.3 to 1.5 billion. In the devices and consumer other segment revenues are expected to be $1.9 billion with growth in Office 365 Home and Bing. In the commercial segment the company expects revenues to be between $13.1 billion and $13.3 billion. Within the commercial other segment, which includes cloud services, revenues are projected to be $2.1 billion.

Conclusion

Microsoft is a fairly valued stock when it comes to valuation multiples. The stock is trading at a trailing twelve month P/E of 15X while in comparison the industry average P/E is 16.5X and the S&P 500's P/E is 18X. The stock is even more attractive with its forward P/E of 13.75X and expected earnings growth for 2015 of 7.4%. Keeping in mind the modest growth, the average target price for this stock is $41.33, which gives rise to an upside potential of 3.56%. However this calculated target price seems to be conservative because when analyzing the stock's performance over the last twelve months Microsoft is up 22.3% and outperformed the S&P 500 that is up 16.9%. So in the given situation more than estimated upside potential can be expected from this stock.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Business relationship disclosure: The article has been written by a Gemstone Equity Research research analyst. Gemstone Equity Research is not receiving compensation for it (other than from Seeking Alpha). Gemstone Equity Research has no business relationship with any company whose stock is mentioned in this article.