Microsoft: Should Investors Continue Betting On A Turnaround?

Jul.18.14 | About: Microsoft Corporation (MSFT)

Summary

Microsoft is doing well to counter PC weakness by moving into the cloud.

Microsoft is trying to be dominant and it is undertaking aggressive strategies to undercut competitors.

Microsoft has a strong cash position that will allow it to continue making investments to sustain its growth.

With a freshly-minted CEO at the helm, Microsoft (NASDAQ:MSFT) is on a solid run this year. The stock is already up more than 13% on the back of its smart strategies and consistent results, as Microsoft has beaten earnings estimates for three quarters on the trot. Now, considering Microsoft's impressive valuation and the fact that it looks set to improve further, it should be able to sustain its strong run. In fact, Microsoft is doing well despite weakness in the PC market, and its foray into emerging technologies is the right move.

Getting better

According to Satya Nadella, Microsoft CEO,

It is important and valuable to see the company with a fresh perspective to get grounded both our current realities and future opportunities.

So, it is clear that Microsoft is going for a change of direction, which is probably the reason behind investors' enthusiasm. In fact, Microsoft is already making progress in various areas such as cloud services, Windows, and Bing. In the third quarter, its cloud services revenue doubled as compared to last year, primarily driven by a strong performance from Office 365 and Azure. Windows reported strong sales from its business customers, with solid growth in both Windows Pro and Windows volume licensing revenues.

Moreover, Bing saw improvement in the online search business, with its U.S. search share growing to 18.6% and search revenue increasing by 38%. Bing's improved performance was a result of Microsoft's innovative moves, as it is intent on delivering solid features such the Cortana virtual assistant for the Windows Phone.

Moves in the cloud

In addition, Microsoft will continue investing in its cloud capabilities, including Office 365 and Azure, in the fast growing software as a service ((SaaS)) and cloud platform markets. The company is working to make its cloud services available across all device platforms. In addition, Microsoft is taking strong initiatives to enhance its Windows business further, with key focus on innovation.

One such innovation that's expected to be rolled out soon is a cloud-based machine learning service, known as Azure ML. As reported by Data Center Knowledge:

The service can be used to help create applications that can predict the future on the basis of previous data. It will help bake predictive analytics into applications, helping organizations use large amounts of data to provide all the benefits of machine learning to a wider audience.

Azure ML will bring together new analytics tools, powerful algorithms that Microsoft developed for products like Xbox and Bing, and the company's many years of experience, into one easy-to-use cloud offering. This knowledge, combined with the infrastructure of the Azure cloud, not only gives access to experience and years of learning, it eliminates the high-cost hurdle.

Azure ML will include a study tool for business analysts to get started, an API for deployment, and an SDK for writing applications. The open source R language will be used to write applications. Some select Microsoft partners are using an early version of the service, and the public preview will be available in July.

This is a classic example of what Microsoft is trying to do -- bringing comprehensive solutions in the cloud in order to accelerate adoption of its products.

Financial impact of the cloud

Microsoft's cloud services are already gaining momentum. According to Forbes, in the last reported quarter:

The company reported 101% growth in commercial cloud services, which includes commercial Office 365 (growth of over 100%) and Microsoft Azure platform (growth of 150%).

Hence, as cloud computing and Microsoft's services gain more steam, the revenue contribution from these services will get better. The company is already seeing strong growth due to Azure, and it is making the platform even better to sustain its revenue growth momentum. Microsoft is expected to add over 40 new features to the Azure platform, making the platform more attractive. The company now generates around $12.23 billion from its cloud services, and considering the rate at which it is growing, it can get better.

Trumping the competition

However, Microsoft faces competition from other companies such as Dropbox, which is competing with it in the cloud storage space. The online file sharing company has gained solid traction in the past few years. In fact, within just six years of its establishment, Dropbox has more than 200 million users. Its ease of use has clicked with users. In addition, Box is another rival in this space, which is more focused toward corporate customers who demand greater levels of administrative control and security. Thus, Microsoft may have a tough time in the cloud space.

However, Microsoft is not sitting idle. It recently made its online storage solution more affordable with a price cut and an increase in capacity. As reported by InfoWorld:

Microsoft will dramatically increase capacity and lower prices for OneDrive, increasing pressure on other cloud storage providers and also sweetening the deal for prospective and current Office 365 customers.

The company will more than double to 15GB the storage capacity in the free, stand-alone OneDrive service for consumers. People get access to this free OneDrive storage also when they sign up for Office Online, the free, lightweight Web-based version of Office, and also when they sign up for Outlook.com, Microsoft's free webmail service.

Microsoft is also slashing the cost of additional storage for OneDrive. An extra 100GB will now cost $1.99 per user/month, down from $7.49, and 200GB will cost $3.99 per user/month, down from $11.49.

For Office 365 Home and Office 365 Personal customers, Microsoft is also sending OneDrive storage through the roof, from 20GB to 1TB per user.

Quite clearly, Microsoft is leaving no stone unturned to impose its dominance, and moves such as this should allow it to bring more users into its ecosystem. The company will continue focusing on two key areas to improve its business going forward.

Fundamentals and conclusion

Microsoft has a trailing P/E of 15.83, and a forward P/E of 14.67 indicates that the company will be able to grow its earnings going forward. In addition, Microsoft has a lot of cash that it can use to further its development. According to Yahoo! Finance, Microsoft has cash of $87.7 billion, and its debt position is relatively reasonable at $23.48 billion. As such, a strong financial position should allow Microsoft to continue move into the cloud and continue its resurgence.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.