Huge Catalyst for MSFT Stock
The bears are feeding on Microsoft Corporation (NASDAQ:MSFT) stock after the tech giant reported weaker-than-expected earnings last Friday. MSFT stock is down about seven percent since the earnings call, but the bears have it wrong. MSFT stock could still see major upside over the next few years. Here’s why.
Microsoft reported fiscal 2016 third-quarter revenue of $22.1 billion and adjusted earnings per share of $0.62, which fell well below forecasts. Analysts were expecting about $22.0 billion in revenue and $0.64 in earnings per share.
On a non-GAAP basis, revenue increased 1.5%, but if it weren’t for currency fluctuations, that number would have been five percent. (Source: “Earnings Release FY16 Q3,” Microsoft Corporation, April 21, 2016.)
So all in all, the numbers look kind of bad, but that doesn’t justify a seven-percent sell-off in MSFT stock. The quarter actually wasn’t as bad as the numbers suggest, and investors have failed to look past it.
One reason earnings came in lower than expected was that Microsoft was hit with a surprise tax rate of 24% rather than the 19% or 20% the company usually incurs. (Source: Ibid.) Microsoft’s director of investor relations told TechCrunch that if it wasn’t for the tax provision, earnings per share would have been $0.64, beating analyst expectations. (Source: “Microsoft’s Q3 misses with EPS of $0.62, revenue in line at $22.1B,” TechCrunch, April 21, 2016.)
However, when it comes down to it, investors hit MSFT stock hard because growth isn’t coming in as quickly as anticipated. But investors need to look long-term because that looks more promising for MSFT stock.
Microsoft is currently transitioning from a PC-based company to a cloud-first company, and that will take a bit of time to pay off. It’s all part of Microsoft CEO Satya Nadella’s plan, as he hopes to capture new large revenue streams from cloud service subscriptions. This is the future for Microsoft and it should be a major catalyst for MSFT stock over the next few years.
While investors wanted more, especially from the cloud business, there are a couple of bright spots that will drive future sales.
One standout in the cloud business is the company’s “Office 365” product suite. Nadella took the old Office suite, which charged users every couple of years for a licence, and moved it to the cloud, where users now pay a monthly fee instead.
Microsoft hasn’t given a revenue breakdown for Office 365, but in the latest quarter, Microsoft said that revenue grew 63% on a constant currency basis over the same time last year. It also now has 22.2 million subscribers, up from 20.6 million subscribers in the previous quarter.
Bernstein analyst Mark Moerdler forecasts that the cloud version of Office 365 had annual sales trending to $6.5 billion in the most recent quarter. (Source: “Microsoft Office Shines in the Cloud, Azure Will Be Profitable, Says Bernstein,” Barron’s, April 8, 2016.) That’s out of total commercial cloud revenue that Microsoft reported of $10.0 billion in annualized sales. (Source: Microsoft Corporation, op cit.)
So Office 365 is growing like crazy, but that’s not the only bright spot in Microsoft’s cloud business.
In the battle for cloud computing services, “Microsoft Azure” is second to Amazon.com, Inc.’s (NASDAQ:AMZN) “Amazon Web Services” (AWS). However, Microsoft is starting to gain. While Azure has about 10% of the market to AWS’s 30%, Azure is becoming bigger and bigger and it’s bound to erode Amazon’s lead.
In the latest quarter, Azure grew 120% on a constant currency basis, which is almost double AWS’s growth. (Source: “How Microsoft’s Azure Is Giving Stiff Competition to Amazon’s AWS,” Yahoo! Finance, April 8, 2016.)
Again, Microsoft didn’t break down revenue for Azure but according to Bernstein’s Moerdler, Azure’s annual sales run rate is about $1.8 billion. (Source: Barron’s, op cit.)
With these kinds of growth rates, Microsoft shareholders are sure to eventually be rewarded.
The Bottom Line on MSFT Stock
It may be taking longer than expected, but Microsoft is successfully making the transition from the PC to the cloud. And with products like Office 365 and Azure growing at a rapid clip, MSFT stock is sure to benefit when the transition is complete.