Microsoft Earnings: Growth In Right Areas Help With Transition
Summary
- From our standpoint, Microsoft grew in the areas it needed to during the quarter and shrunk in areas where we expected negative YoY growth.
- We believe Bing's market share growth is significant for Microsoft as it shows that despite Google's success, Bing is able to co-exist and continue to penetrate the market.
- Commercial cloud accelerated sequential growth of 27% vs. 15% the quarter before representing ramped up adoption of Microsoft's cloud products.
- Off-balance sheet revenue was $24.5 billion, which essentially means Microsoft has $24.5 billion in revenues under contract that were not recognized in Q4 that will be recognized in future quarters.
- We believe certain metrics in the report signaled strong future tailwinds from Microsoft's cloud transition.
Microsoft (NASDAQ:MSFT) announced Q4 earnings July 21 after the close and investors weren't too thrilled by the results.
From our standpoint, Microsoft grew in the areas it needed to during the quarter and shrunk in areas where we expected negative YoY growth. We believe the quarter is an accurate representation of a company in transition to a cloud-based business.
Office Consumer revenues were down 42% YoY, which is to be expected as the company transitions its user base to Office 365. The numbers show that Microsoft is doing as the Office 265 subs base grew by 3 million sequentially to 15.2 million by quarter's end. Office 365 revenues also grew $58 million in the quarter. While this is much less than the revenue lost by Office Consumer YoY, this is to be expected as Office 365 is ARR, or annual recurring revenue.
Xbox sales were up 10% driven by volume growth from 1.1 million to 1.4 million. This represents Microsoft's continued ability to distinguish Xbox from the Playstation platform. Xbox Live sales grew with hardware sales, a good sign of growing ARR.
Lumia phone revenue was down, but volume was up from 5.8 million to 8.4 million. We are concerned about Microsoft's mobile performance, though believe Cloud ARR could offset these losses soon.
Surface sales grew 117%, starkly contrasting Apple's poor iPad performance MRQ. The difference between consumer demand for the Surface vs. the iPad in the tablet market only continues to widen, and we believe this benefits Microsoft as the technology world continues to transition away from PC.
Bing grew market share to 20.2%, representing Microsoft's successful execution to a new-look business. With Google (GOOG) (GOOGL) soaring past results this past week, we believe Bing's market share growth is significant for Microsoft as it shows that despite Google's success, Bing is able to co-exist and continue to penetrate the market.
Commercial cloud ARR grew 88% (or 96% in constant currency) to $8 billion. This continues strong sequential growth from two quarters ago ($5.5 billion) from last quarter ($6.3 billion) to this quarter. The accelerated sequential growth of 27% vs. 15% the quarter before represents ramped up adoption of Microsoft's cloud products.
The most notable figure in the earnings report, though, was the $24.5 billion in off-balance sheet revenue, which is essentially revenues under contract Microsoft has that were not recognized in the quarter but will be recognized in future quarters. This figure is an all-time high and represents the core success of Microsoft's transition to a cloud-based business.
The company reported operating cash flow of $6.8 billion and capital expenditures of $1.8 billion for the quarter, meaning Microsoft generated $5 billion in free cash flow for the quarter. This is down from Q4Fy14's FCF of $8.2 billion, but we believe FCF generation of $5 billion is strong for a business which saw its two highest-margin operating segments decline in revenue.
Microsoft also declared a cash dividend of $0.31 for the quarter, or an annualized dividend of $1.24. At current market value, that is a dividend yield of 2.73%. The $1.24 dividend represents an 8% hike YoY. According to a constant growth DDM with a 6% dividend perpetuity rate and 8.2% WACC discount rate, Microsoft's fair value could be north of $56.
All in all, we feel Microsoft's quarter, while not exceptional, was good and what should've been expected of a company in a transition period to a cloud-based business. We believe certain metrics in the report signaled strong future tailwinds from Microsoft's cloud transition.
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