We reviewed our position on Microsoft, maintaining our Buy recommendation and increasing our Price target from $125 to $145. The increase in price target is mainly a result of an increase in the forward multiple from 27x to 30x factoring in a strong improvement in margins going forward.
The increase in price target reflects our conviction that Microsoft is starting to become a predictable growth story that will continue to provide steady estimate revisions for long-term investors. We also like Microsoft (similar to Amazon) due to its involvement in cloud computing.
The stock regained the $1 trillion level in market capitalization, placing it in an elite club alongside only Apple and Amazon. On 9th June 2019, Microsoft demonstrated a new Xbox console labelled ‘Project Scarlett’ due out in 2020, as well as a new cloud gaming service.
Microsoft now owns LinkedIn, Skype and GitHub, in addition to its legacy Windows operating system and the Xbox gaming and Office 365 businesses.
The Group is arguably the leader in the cloud services market with Windows Azure and Office 365. It can drive better earnings growth as it transitions Office and Windows to its cloud platforms.
Microsoft’s units
Microsoft's cloud-computing unit – This unit generated 29% of total fiscal 2018 revenue and 33% of operating income. Demand for cloud offerings drove commercial cloud revenue to $9.6 billion in Q3 2019, up 41% year-over-year.
The Productivity and Business Processes unit - This encompasses Microsoft's Office 365 products and subscriptions, its Skype and LinkedIn businesses, and its Dynamics enterprise resource planning and customer relationship software. Combined, those businesses produced 32% of Microsoft's $110.36 billion in revenue for 2018. Revenue in Productivity and Business Processes was $10.2 billion and increased 14% in Q3 2019.
Personal Computing unit - This comprises all of the Company's Windows operating-system businesses, as well as devices including Surface computers. It also includes Microsoft's popular Xbox gaming systems. This segment brought in 38% of revenue and 30% of income. It is the slowest-growing segment of Microsoft, but it remains profitable. Revenue in Personal Computing was $10.7 billion and increased 8% in Q3 2019.
Q3 2019 Results
· Revenue was $30.6 billion and increased 14%
· Operating income was $10.3 billion and increased 25%
· Net income was $8.8 billion and increased 19%
· Diluted earnings per share was $1.14 and increased 20%
Valuation
Our $145 price target is based on a forward Price-to-earnings ratio of 30x and a discount rate of 10%. We are discounting 3 years of future profits to come up with the price target.
Conclusion
Microsoft is an investor-friendly company focused on growth. Management are now also more open on margin expansion and cash returns. While the PC cycle and Windows dynamic are still highly relevant, we believe Microsoft is pushing forward with a successful cloud strategy.
We have a positive outlook on Microsoft and believe the Group is well positioned to continue to benefit in the short to medium term.
About the company
Microsoft Corporation is an American multinational technology company with headquarters in Redmond, Washington. It develops, manufactures, licenses, supports and sells computer software, consumer electronics, personal computers, and related services. Its best known software products are the Microsoft Windows line of operating systems, the Microsoft Office suite, and the Internet Explorer and Edge web browsers. Its flagship hardware products are the Xbox video game consoles and the Microsoft Surface lineup of touchscreen personal computers. As of 2016, it is the world's largest software maker by revenue, and one of the world's most valuable companies. The word "Microsoft" is a portmanteau of "microcomputer" and "software".
This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri at Calamatta Cuschieri. For more information visit, www.cc.com.mt . The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.