The Right Time To Buy Microsoft

Jul.30.14 | About: Microsoft Corporation (MSFT)


Despite having decent revenue growth, Microsoft missed the earnings estimates in the fourth quarter of fiscal year 2014.

China has temporarily lifted the ban and Microsoft, in collaboration with China Telecom, will be selling Xbox Ones starting from September of 2014.

Microsoft reported diluted per share earnings of $2.63 with a net income of $22.07 billion for full year 2014 reflecting an increase of around 1% from the previous year.

There have been lots of happenings at Microsoft (NASDAQ:MSFT) after Satya Nadella took the CEO position a few months ago. Within a few months Nadella made important decisions that should have been done in the past in order to retain Microsoft's top spot in the PC industry. Microsoft experienced challenges during the last several quarters in terms of its earnings. This is evident from the fact that Microsoft missed the consensus earnings per share in the 2nd calendar quarter of 2013 by -20.27%. The PC industry declined sharply and the company's excessive dependence on the PC industry is the reason why Microsoft missed the earnings estimates.

Strong Financial Results

Despite having decent revenue growth, Microsoft once again missed the earnings estimates in the fourth quarter of fiscal year 2014. The situation is likely to change soon because Satya Nadella has big plans for Microsoft and during his tenure as CEO shares went up close to 23%. Microsoft's quarterly revenues stream increased 17.5% from $19.89 billion in the fourth quarter of 2013 to $23.38 billion. However, net income was $4.6 billion reflecting a decline of 7.1% from $4.97 billion and also behind Wall Street analysts' consensus estimates of about $5 billion. Earnings per share fell 4 cents to $0.55 and were a nickel short of Wall Street's estimate. For the full year, revenues reached $86.8 billion reflecting an 11.5% increase from $77.85 billion in 2013. Microsoft reported diluted per share earnings of $2.63 on a net income of $22.07 billion reflecting an increase of around 1% from the previous year.

Source: Earnings Release


Recently Microsoft announced it would be laying off 18,000 workers or 14% of its workforce as it reduces overlap with Nokia (NYSE:NOK) 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 move to steer Microsoft away from former CEO Steve Ballmer's emphasis on consumer devices. The first was his decision to make Office available on the iPad and this strengthened Microsoft's position as the dominant maker of office productivity software.

Microsoft generated $1.99 billion in phone revenues for the quarter. That revenue had an operating loss of $692 million attached to it.

Xbox One Launch in China

Microsoft renamed its D&C hardware segment to Computing and Gaming hardware in the fourth quarter of fiscal year 2014. This segment's revenues increased $274 million or 23%, driven by higher Surface and Xbox platform revenues. The Xbox One console has been facing stiff competition from PlayStation 4, which remained best-selling console in the U.S. last month. To combat the competition Microsoft launched a cheaper model of the Xbox One with a price tag of $399 and this strategy returned some good numbers as Xbox sales doubled in the last two months. Xbox experienced decent growth and its revenues increased $104 million or 14% with quarterly sales units of 1.1 million compared to 1 million units in the fourth quarter of 2014.

Going forward, further growth is likely because Microsoft is set to launch the Xbox One in China in September through its collaboration with China Telecom. China has temporarily lifted a 14 years old ban on selling video game consoles. Although China saw video game revenues grow by more than a third in 2012 to nearly $14 billion in last year, pricing may still be a challenge for Microsoft because more than 70% of Chinese gamers earn less than $634 a month. Despite all of these factors, if carefully priced, Xbox can gain a slice of the video game market in China. Microsoft is already one step ahead of Sony (NYSE:SNE) who revealed in May of 2014 that it was preparing to launch its PS4 in China after forming a joint venture.


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Source: ycharts

Satya Nadella appears to be doing a fine job of remaking Microsoft. However, Microsoft's rival Apple (NASDAQ:AAPL) is also making moves. Apple and International Business Machines (NYSE:IBM) recently announced plans to join forces on the enterprise front. Recent developments indicate that Microsoft is repositioning itself to ignite more earnings growth. Due to the potential growth Microsoft's stock is priced at a modest premium compared to Apple and Microsoft is trading at a trailing price to earnings multiple of 16.63 times and 15.49 times forward earnings, compared to the 16.23 earnings multiple and 13.93 times forward earnings multiple of Apple. Microsoft's stock also went up about 23% year to date implying that the market is already reflecting much of the good news in the stock.

Microsoft is a solid buy at its current prices. Microsoft's stock is by no means expensive by the standards of today's market and it is valid to expect earnings growth to accelerate in the coming quarter. Microsoft continues to strengthen itself as its Surface Pro 3 makes progress, Xbox One goes on sale in China, Microsoft Lumia phones sales continue growing and Nadella's growth initiates really start to bear fruit.

Disclosure: The author has 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.