Microsoft: Strong Quarter Affirms Diverse Growth Potential

| About: Microsoft Corporation (MSFT)

Summary

The highlight of the ER for us was Office 365, which posted strong growth but also shows promising growth potential with LNKD.

The Surface continues to distinguish itself from the iPad in terms of consumer popularity.

The cross-platform Xbox/Windows 10 gaming experience has been and will continue to be a catalyst in the gaming segment.

At 20x LTM adjusted earnings, MSFT shares still feel attractively valued.

Microsoft (NASDAQ:MSFT) reported a strong Q4 which, in our opinion, affirms the company's diverse long-term growth story. MSFT currently seems to us like a tech behemoth firing on all cylinders, and with the valuation still at reasonable levels, we see no reason to not be long the name.

The highlight for us was Office 365. Office 365 commercial revenue grew 59% ex FX, a continuation of what has been a decelerating YoY growth rate trend this year (Q1 and Q2 came in at 70%, and Q3 reported 63% constant currency growth). Sub growth also is slowing sequentially, with only 900,000 Office 365 subs added this quarter relative to 1.6 million in Q3 and 2.4 million in Q2.

While Office 365 growth is clearly slowing, we expect growth to accelerate over the next several quarters as synergies with LinkedIn (NYSE:LNKD) kick in. When MSFT first acquired LNKD, we wrote a bullish piece on how the biggest beneficiary of the acquisition was Office 365. We argued that because all professional work is done in a doc, spreadsheet or presentation, an Office-365-integrated LNKD news-feed would inevitably drive both greater LNKD engagement and Office 365 adoption.

Management's commentary on the CC confirms these potential synergies. Forward-thinking CEO Satya Nadella said on the call that he looks at what his company is doing with Office 365, Dynamics 365, AppSource and LNKD as "all being part of one strategy." In Nadella's words, that strategy is "to connect the world's professional cloud and the world's professional network with our pending LinkedIn deal." Nadella's commentary on the call essentially mirrors our preliminary thesis that MSFT has a unique opportunity to consolidate the professional cloud and, namely, establish Office 365 as the norm for cloud-based "office" work. Microsoft Stream also will help push things along in this strategy of professional cloud consolidation.

Beyond Office 365, other things of note in the report were Surface, Azure and Xbox. Surface growth stalled somewhat to 9% from 61% last quarter, but this slowdown is to be expected given we are now two quarters out from the Surface Pro 4 and Surface Book launch. Again, positive Surface growth stands in stark contrast to the Apple (NASDAQ:AAPL) iPad's -19% MRQ growth. We maintain that Surface continues to distance itself from the iPad in terms of consumer popularity, and believe further Surface iterations will re-ignite strong YoY Surface growth.

Azure posted yet another triple-digit gain quarter, thus completing a full year wherein Azure grew triple-digits in every quarter. Growth is naturally slowing per law of large numbers, but the growth trajectory is nonetheless impressive.

Interestingly, Xbox had its best quarter this year. The 33% YoY MAU growth in the quarter was the highest mark this year, as was the 49 million MAU base in the quarter. Hours spent gaming on the Xbox One grew 13% sequentially, while hours spent gaming on Window 10 PCs grew 19% sequentially. There's clearly a great deal of excitement around the cross-platform gaming experience shared between Windows 10 and Xbox, and this excitement should only grow with AR and other advanced Xbox iterations.

With all these early-stage, hyper-growth products and services that look to have significant sales longevity, MSFT has strong earnings growth potential over the next several years. We think the LNKD deal only strengthens that earnings growth potential. The after-hours quote puts the stock right around 20x LTM adjusted earnings, which is still a marked discount to the market P/E of 25x.

For a company with such a wide moat and several different, promising growth prospects, 20x still feels like an attractive multiple. We think the MSFT growth story still has a lot of room to run and that investors should remain long the name even though it has had solid 17%+ run-up over the past 12 months.

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Disclosure: I am/we are long MSFT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.