Microsoft To Unlock Synergistic Value Through Cloud Integration

Sep.23.11 | About: Microsoft Corporation (MSFT)

Integration finally appears to have arrived at Microsoft Corporation (NASDAQ:MSFT). Over the years, Microsoft has developed software products and acquired companies without unlocking the potential revenue and cost synergies. As the technology company develops its promising new operating system, Windows 8, it will attempt to bring its capabilities together in a way that locks out competition. Below is a breakdown of the company's current revenue sources.

Analysts are rating the company around a "buy" under the belief that the current valuation of 8x forward earnings at a PEG of 0.83 prices the software-maker below its intrinsic value. Consensus estimates for EPS are that it will grow by 6.3% to $2.86 in 2012 and then by 9.4% and 11.8% in the next two years. Given the tremendous upside, this stock offers favorable risk asymmetry offering around a 3% dividend yield.

In regards to the upside, management has emphasized that the company is orienting itself around cloud capabilities in order to integrate the products. This approach will work smoothly for Microsoft Office, Xbox, Skype, the upcoming phone "Mango", and the billion-dollar shredder Bing. The Windows 8 operating system will feature a new UI akin to Metro-themed app layouts and will be available with touch screen and cloud abilities. It will also be designed to operate on different mediums from phones to tablets.

Microsoft has also strategically partnered with firms like Nokia (NYSE:NOK) and Hulu. Xbox will experience accelerating syndicated content from Hulu in a way that allows Microsoft to cut costs in the process. At the same time, the firm also spends a higher percentage of its sales on R&D than most of its peers, which I feel is excessive given that the firm has enough to work with already. While Microsoft struggled during the emergence of smart phones and search engines, I believe that investors are exaggerating the extent to which the firm will have difficulties competing in the future. With the ability to consolidate software beyond competitors, Microsoft should have no trouble growing in the fast-moving technology industry.

With that said, Apple and Google are major obstacles for Microsoft. Apple's (NASDAQ:AAPL) Macintosh computers and operating system have gained popularity among the youth and college students. And Google's (NASDAQ:GOOG) search engine has strong loyalty among its users, in addition to being one of the first websites a web surfer browses. Google, in particular, I believe has done a stellar job in branching out. There are strong possibilities for each one of these competitors in the future, but Microsoft could very well cut growth short for both of them.

Skype has grown its user base substantially and Office 2010's sales are several folds higher than what they were for Office 2007 at the same time following release. I forecast revenue growing by 5.7% to $73.9B in 2012 and then by 6.9% the next year. These estimates are slightly below what other analysts have forecasted. Nevertheless, they should generate enough cash flow to finance what could be a value-creating integration phase that provides for a much greater return in the next five years.

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