Why The 'Cloud Guy' Is The Right Guy To Run Microsoft

| About: Microsoft Corporation (MSFT)
This article is now exclusive for PRO subscribers.

Honestly, I have to congratulate Satya Nadella for being named CEO of Microsoft (NASDAQ:MSFT). He's just the man for the job, and it's in-line with what I was anticipating following the disappointing news that Alan Mulally would not move to Microsoft. Despite that fact, I think Satya Nadella is a vastly more competent CEO than both Steve Ballmer and Stephen Elop. You have to owe the success of Steve Ballmer to the successful management of the enterprise and commercial division. In fact Microsoft's commercial business is larger than the consumer business, and it is growing faster than the consumer business. It seems Microsoft's cheese has moved to the cloud. Who could be a better contender, for leading the shift from the World Wide Web to the Application web?

While past performance isn't always indicative of future results, what Microsoft needs in a leader is a talented executive that can spot opportunities in the cloud and move the business to capitalize on those specific opportunities. Thankfully the board hired the right guy.

Massive shifts in software and web

Software-as-a-service is an overused terminology by experts in the field. For the duration of the article, I'm going to refer to SaaS as software cloud. SaaS is where applications are accessed via the internet with data stored on a virtual server. The program and data storage can be accessed from a multitude of different web capable devices; centralizing data onto the web makes it easier for consumers to transition from one computing device to the next. This leads to a unique change in market positioning for standard PC OEMs, software vendors, and consumer electronics.

The cloud adds a lot of utility to the average enterprise. The primary business model for the software cloud has been subscription based revenue or freemium. The primary form of distribution will be application stores. Hence I believe the World Wide Web will be a secondary destination and will be overtaken by the application stores, which I refer to as the application web. The World Wide Web won't completely die, but it will become secondary to the burgeoning number of applications. Why? Because applications can be accessed across all the form factors, and since data is stored on the cloud, the information and user experience transition more simply between different devices. The cost of developing an application is substantially less than developing a website. The distribution mechanism is vastly better. It is way easier to set up a way to collect payments through the Android or iOS application store than it is to include a PayPal (NASDAQ:EBAY) checkout on a web page. The World Wide Web has become inefficient and it's on its way out the door.

When Apple (NASDAQ:AAPL) came up with the original application store, it was disruptive and ended the era of packaged software. At some point, I expect software to be bought from the application web only. Software will be accessed from a multitude of devices and will come with a unique user experience that works across tablet, smartphone, wear-ables, consoles, and PCs. This trend is emerging for more well-established applications, but will trickle-down to less-known apps as well. I expect many more web capable devices, and that the average consumer will use more than five by 2020.

When we saw the Apple app store, we thought it would change software distribution, but no one would have thought that it could have changed the very nature of the internet so that your standard web browser would feel extremely inefficient. In the past quarter, users accessed Facebook through an application more than through a web browser (based on mobile revenue). This is why I think the application web is the face of the new web.

With so much change expected in the technology environment over the next five years, the last thing you ever wanted was a guy on the consumer side. Sure, Satya doesn't have a mysterious recipe that will make Nokia handsets the standing ovation of luxury. But at least he'll protect Microsoft's core business of software from further corrosion, by keeping Microsoft current with a rapidly changing environment.

Satya's got potential

Satya Nadella has been at Microsoft for more than two decades. He runs one of the biggest organizations in the world, and has strong leadership skills. He's never been the CEO of a company, and he isn't an original founder, but he was instrumental to Microsoft's continued success in commercial enterprise.

Microsoft has a great track record when it comes to internally promoting candidates into the CEO position. While it's true that Steve Ballmer was never able to turn Microsoft into a powerhouse on the consumer end, the company sustained revenue and earnings growth. Shareholders never really rewarded his efforts when it came to controlling costs and sustaining growth, but at least he kept Microsoft from becoming a cash bleeding mess.

The company needs to turn its attention to innovation, which is something that Satya Nadella stresses throughout his CEO succession interview. While innovating is important, it's important that Microsoft is able to turn its focus on things that the company can do well. Both innovation and focus on a set of core competencies will keep Microsoft relevant. Hence, the One Microsoft strategy is perhaps the most crucial element to whether Microsoft can sustain its success.

Microsoft needs to convince consumers that it has the most superior platform for computing in general. Many have migrated to the Mac, and iOS to fulfill computing needs. Besides innovation, what's needed at Microsoft is a bit more risk taking. The acquisition of Nokia's handset division resulted in a mixed response from shareholders, but it seems to be the right step, for Microsoft. Microsoft has been able to prove that it can successfully sell hardware (Xbox One), whereas Google (NASDAQ:GOOG) destroyed Motorola by buying them out. A mix of acquisitions, product development, and execution on unique business opportunities would be required for Microsoft to sustain bottom and top line expansion.

Going forward, Microsoft is well positioned on the software cloud side of the business, and it's also on its way to becoming one of the major intermediaries in application sales through the Windows application store. Granted, the content collection isn't as robust as Android and Apple, but I expect this to improve depending on whether or not Microsoft acquires another mobile OEM or secures partnerships with Samsung (OTC:SSNLF), Lenovo, and Sony (we're still in the rumor stage at the moment).

Microsoft may release Windows 9 in 2015, which would enable applications to be cross compatible regardless of form factor and CPU architecture (both ARM and X86 will run the same programs at some point). This will allow Microsoft to collect royalties on any application sold across PC, tablet, mobile, and Xbox. A stronger ecosystem should eventually boost marketshare, which would result in Microsoft earning even more revenue on hardware. Microsoft's greatest advantage in the future will be its versatility.

For now analysts have low expectation for Microsoft with a long-term growth rate of 7.45%. Some may wonder if such a large organization can generate growth that could reach double digits. I'll be the first to admit that technology is a rapidly shifting environment, and at times it's really unpredictable. Despite this fact, perhaps single digit growth is a bit of a stretch when considering the sheer potential from subscription licensing from office products, and the myriad of other applications (Skype, Azure, Microsoft Dynamics CRM) that Microsoft develops and distributes.

Conclusion

I think the board was right in choosing Satya Nadella for the job. The board decision was unanimous, which comes to show how highly the board thinks of their new CEO. Perhaps Microsoft has all the ingredients it needs to sustain even greater levels of success.

Satya has a massive war chest available to fight back against rising tech giants like Samsung, and push more established players like Sony to engage in self-destructive tendencies (price war). Clearly, Microsoft still has the ability to strong-arm its rivals. For now Microsoft retains its position as one of my favorite picks for 2014. I couldn't be happier they chose the "cloud guy" to run Microsoft.

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