Microsoft Earnings: The Nadella Makeover Is Working

Jul.23.14 | About: Microsoft Corporation (MSFT)

The numbers are in: Microsoft (NASDAQ:MSFT) reported fiscal fourth-quarter earnings per share of $0.55 on revenues of $23.38 billion. This is actually a pretty substantial earnings miss for MSFT-the Wall Street consensus was for earnings per share of $0.60-though revenues came in better than the expected $22.99.

The main culprit? Fallout from the Nokia acquisition, which has been a mixed bag at best for Microsoft. The Nokia acquisition reduced earnings per share by about 8 cents. Inventory adjustments to its Surface tablet also chopped another 7 cents off of Microsoft earnings per share.

MSFT stock actually rose in after-hours trading, so the Street seems to be taking the news in stride and focusing instead on the positives. Revenues from the Bing search engine were up 40%, and Bing now has a U.S. market share of about 19%. And the Windows unit-which has been hurting for the past several years-also showed signs of strength for MSFT, with revenues up 3%. This was driven mostly by business spending on new PCs, something that "Wintel" partner Intel (NASDAQ:INTC) confirmed in its earnings release earlier this month.

Microsoft's transitioning of Office from a "shrink-wrapped" software suite to a subscription service is also doing well. MSFT added more than a million new Home and Personal subscribers to Office 365.

But the biggest news-and something that bodes very well for MSFT's future-is the smashing success of its cloud business. Per Microsoft, "Commercial cloud revenue grew 147% with an annualized run rate that exceeds $4.4 billion."

$4.4 billion is still chump change to a company that does $87 billion in annual revenues. But MSFT's success here is critical to CEO Satya Nadella's vision for the company's future as an enterprise and cloud services company.

"Bold ambition" is what Nadella promised to deliver in a memo to employees earlier this month. And he's off to a good start. Wall Street reacted well to his attempts to make MSFT leaner and meaner: earlier this month, MSFT announced it would be laying off 18,000 workers-or fully 14% of its workforce-as it reduces overlap with Nokia, whose devices business it acquired last year. But even outside of Nokia-related layoffs, the company will be letting go of about 5,500 workers, or about 5% of its pre-Nokia workforce.

This is Nadella's second major concrete move in his attempts to steer MSFT away from former CEO Steve Ballmer's emphasis on consumer devices. The first, of course, was his decision to make Office available on the iPad-a move that strengthens MSFT's position as the dominant maker in office productivity software but weakens its position as a seller of tablets such as the Surface.

So, what does all of this mean for MSFT stock going forward?

Nadella appears to be doing a fine job of remaking Microsoft. But his competition hasn't sat idly either; just last week, Apple (NASDAQ:AAPL) and IBM (NYSE:IBM) announced plans to join forces on the enterprise front. MSFT stock is priced at a modest premium to AAPL: MSFT trades for 17 times trailing earnings and 16 times forward earnings, compared to 16 and 14, respectively, for Apple. MSFT stock is also up about 20% year to date, implying that the market has already priced in much of the good news.

Still, would consider MSFT a solid buy at today's prices. MSFT stock is by no means expensive by the standards of today's market, and I would expect earnings to accelerate in the coming quarter as the legacy PC businesses continue to firm up and as Nadella's growth initiatives really start to bear fruit.

Original post

Disclaimer: This article is for informational purposes only and should not be considered specific investment advice or as a solicitation to buy or sell any securities. Sizemore Capital personnel and clients will often have an interest in the securities mentioned. There is risk in any investment in traded securities, and all Sizemore Capital investment strategies have the possibility of loss. Past performance is no guarantee of future results.