Why Microsoft Is Back On The Offensive

Aug. 4.14 | About: Microsoft Corporation (MSFT)

Summary

A new Microsoft has emerged, and Wall Street has applauded that the company is close to regaining its bully status.

Microsoft is now fully armed to attack Apple and Samsung in ways it couldn't before.

The good news is that the company still has plenty of runway to use. And execution will be key.

It's no longer the 1990s, but Microsoft (NASDAQ:MSFT) has not forgotten its bully pedigree. With news surfacing Friday that the software giant has filed a lawsuit against Samsung (OTC:SSNLF) over royalty payments related to the Android operating system, investors are checking their calendars to make sure they had not ventured back a couple of decades.

Although Microsoft is far removed from the Bill Gates-led villain that it was in the mid-1990s, the company is roaring back. The stock closed Friday at $42.86, down 0.7%. But the stock is up more than 16% year-to-date. If not for the recent market downturn, shares were up by as much as 23%, tripling the tech sector's 8% gain. The question is, can this continue?

Some investors doubt Microsoft can withstand Apple's (NASDAQ:AAPL) recent enterprise partnership with IBM Corp. (NYSE:IBM). But Satya Nadella, the company's new CEO, has a strong pulse on Microsoft's future.

While Windows and Office continue to dominate Microsoft's revenue and profits, the company appears more diversified than ever before. Note, the devices and other consumer revenue advanced 20.3% to close to $2 billion. And that's with margins expanding to 23.7%. Not to be outdone, the company posted a 40% increase in its search business as Bing grew its U.S. market share to close to 20%.

In other words, Nadella is working to develop new, fast-growing businesses to lessen Microsoft's dependency on PCs. He has begun to focus on areas like Office 365, its Azure cloud platform and commercial cloud services. These are still relatively small segments that are growing revenue at a rate of over 100%.

Even more important, these businesses offer strong gross margins of 25%, which were up roughly 7% in the most recent quarter. In other words, Microsoft, which is known for printing money, can grow its bottom line in these untapped areas - regardless of what Apple and IBM do. To that end, the market needs to start changing the narrative of how Microsoft has underperformed Apple.

Consider, Microsoft has posted double-digit year-over-year revenue growth in each of the previous five quarters, including a 10% jump in the July quarter and a 20% surge in the January quarter. In fact, during that span, Microsoft has averaged 16% year-over-year revenue growth. The stock has responded accordingly.

And with the company now in full possession of Nokia's (NYSE:NOK) handset business, Microsoft is now fully armed to attack Apple and Samsung in ways it couldn't before, especially with Nokia's devices and services business now getting full attention.

Recall, Nokia's phone business was losing money each quarter prior to Microsoft's acquisition. Nadella believes he can grow that business and turn a profit. And this is one of the reasons why Microsoft is now going after Samsung which (according to Microsoft) breached its royalty payment contract following Microsoft's deal for Nokia's devices business.

It certainly seems as if a new Microsoft has emerged, and Wall Street has applauded that the company is close to regaining its bully status. What's more, unlike when Steve Ballmer was at the helm, Microsoft is finally getting the benefit of the doubt that it never enjoyed before.

That said, although the stock is trading much better these days, Microsoft is not back to full strength. And that's both good news and bad news. It's bad news that Apple and IBM can potentially derail Microsoft's cloud efforts. But it's good news that the company still has plenty of runway to use. And execution will be key.

Disclosure: The author is long AAPL.

Business relationship disclosure: 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.

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