Microsoft Corp. may not be your dog by traditional investing measures. In the end, it generated more than US$22 billion in revenues in the second quarter, returned US$6.7 billion to shareholders, pays a couple.6 percent dividend, and it has a ton of cash on the balance sheet. But that certainly doesn’t make it a winner either.
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After dominating the once high-growth PC market during the technology sector’s heyday and unable to do wrong within the market’s eye, the stock really hasn’t done much for over a decade.
The problem was simple, and something many industry leaders with near-monopoly positions face: it became complacent even though its key markets started to shift, and it lost focus.
In particular, Microsoft has never really made the transition from desktop computers to mobility and also the cloud. The organization has a presence, but it’s no match for several more agile competitors like Apple Inc. and Salesforce.com Inc.
As a result, many investors and consumers now consider this former tech darling a dull company that\’s quickly fading into irrelevance. But perhaps this still-giant player merits a second look, because it will take Satya Nadella, who took control of the helm from Steve Ballmer in February 2014, a little time to right the ship.
Ballmer simply wasn’t in tune with, or didn’t understand, how the industry was changing. It’s not a secret that the PC market is shrinking due to the popularity of smaller-form cellular devices and Microsoft isn\’t the go-to operating system on these units, with users preferring Android, Safari and, obviously, Apple iOS.
But Nadella, with a background in cloud and enterprise technologies, has given Microsoft a forceful push in the right direction, increasing the company’s image in the process, and demonstrating the capability to make difficult decisions.
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One example was the recent restructuring of the phone hardware business acquired through Nokia, which produced an impairment control of US$7.6 billion in the most recent quarter. Microsoft has essentially written off all Nokia’s devices and services business assets it acquired last year.
“The new CEO has definitely implemented a method where Microsoft is proving it\’s successful in adapting,” said Patrick Blais, a senior portfolio manager at Manulife Asset Management.
Some investors seem to agree. Despite a late-July dip after Microsoft released so-so earnings, the stock expires more than 15 per cent in the past 6 months, outperforming both the Nasdaq Composite and S&P 500, in large part because the changes Nadella has been making are showing real signs of working.
The company’s traditional software business is still pressurized, but Blais thinks concerns that Microsoft has been displaced are unwarranted.
“Numerous investors will link Microsoft to the consumer PC market, but there\’s a lot more happening in the company,” he explained. “The company has realized it’s inside a new reality. Apple is going to be successful, so Microsoft has exposed its system so people that want to use its products can access them regardless of which device they will use.”
The company is still an innovator in a number of segments, such as the productivity software it offers through Office 365. Adoption for that mobile suite of office productivity tools continues to be increasing, up to about 15 million users per month out of a customer base of more than 300 million, which leaves room for much more upside.
Microsoft is also scaling up its transition to the cloud and software-as-a-service. Large upfront investments naturally make for challenging financials in early stages, but these should lead to the form of higher margins down the road.
We think Microsoft will dominate in the enterprise, and it stands to benefit from a broad and powerful lineup of cloud solutions
It’s already seeing commercial cloud revenues tracking in an annual rate of US$8 billion, therefore the company’s target of US$20 billion by 2018 looks within its means. Getting more revenues from the commercial side compared to consumer clients are key to Microsoft’s future.
Commercial cloud revenue may represent six per cent of Microsoft’s total currently, nevertheless its organic growth rate is in more than 100 percent, which has both the company and analysts excited.
“While the PC cycle and Windows dynamic are still highly relevant, we believe Microsoft is pushing forward having a successful cloud strategy,” said J.P. Morgan analyst Mark Murphy. “We believe Microsoft will dominate within the enterprise, and it stands to profit from a broad and robust lineup of cloud solutions.”
Investors ought to be pleased with Microsoft’s improved capital allocation policy. More strategic acquisitions are required, but perhaps fewer that appear to be like the US$2.5-billion purchase of Mojang AB, the producer of the Minecraft video game.
Whatever Microsoft chooses to focus on, the key will be discipline on price, which makes it unlikely it will take another run at Salesforce.com Inc., a cloud-focused crm software company, anytime soon.
It’s certainly not the case that Microsoft needs to scrimp since it is sitting on US$97 billion in cash.
Perhaps to keep investors engaged while it changes gears, the company has become more generous with shareholders, raising its dividend and buying back shares at an aggressive pace to the point where it is now paying back more cash flow to shareholders than earning.
That’s the new Microsoft: a company that understands the worth delivered to shareholders isn\’t limited to great products, growing revenues and higher margins, but additionally includes sharing the wealth.
The stock might not be ultra-cheap and still a fair distance from the split-adjusted all-time high near US$60, but considering that Microsoft is generating more free cash flow than the broader market typically, it still has importance of its side.
Changing customers’ perceptions won’t be simple, but Microsoft seems to have more momentum than it has had in quite a while. And that is something investors can finally get excited about.