Tech giant Microsoft has made some significant management changes and has reported solid quarterly results, yet the company’s stock is up just 0.5% in the last 3 months. Are the investors missing something?
Last month, tech giant Microsoft (MSFT, Financial) made significant changes at the top. The company named a new CEO, its iconic founder Bill Gates (Trades, Portfolio) stepped down as chairman, it reassigned the head of the company’s hardware and entertainment products unit to make room for Nokia (NOK, Financial)'s former head Stephen Elop.
The management changes have occurred just weeks after the company released its impressive quarterly results. The company’s shares, however, have largely remained range bound since mid-November between $35 and $38.
Management Changes
A couple of days ago, it was revealed that Microsoft will give Stepehen Elop complete control of the Devices & Studios division by reassigning Julie Larson-Green, once the deal between Microsoft and Nokia closes. Larson-Green has been running the division, which is responsible for all of Microsoft’s hardware and entertainment products including Xbox and Surface tablet, since last year’s reorganization. Larson-Green will become the chief experience officer for the company’s application and services unit which is responsible for several products including Office, Skype and Bing.
In the beginning of February, after months of speculation, Microsoft finally named Satya Nadella as its new CEO. Nadella used to lead Microsoft’s cloud computing and enterprise business, which was the fastest growing operation of the company. Nadella will replace the company’s long running Chief Steve Ballmer, who was in charge for 14 years.
Meanwhile, Bill Gates (Trades, Portfolio) announced his resignation as chairman and will become a “technology adviser” for Microsoft. Both Gates and Ballmer will remain on the board, which will now be headed by the lead independent director John Thompson.
Quarterly Results
The company has also reported second quarter results that were better than the market’s expectations. Its revenues climbed 14.3% from the same quarter last year to $24.52 billion. This translated into earnings of $0.78 per share. The company has easily beaten analysts’ estimates who were expecting profit of $0.68 per share from revenues of $24.52 billion.
The earnings beat was largely due to the strong growth of the commercial segment and better performance from the Devices and Consumer segment during the holidays.
The company operates through two businesses: Devices and Consumer, which includes three segments, and Commercial business, which includes two segments.
Devices and Consumer business grew by 13.3% to $11.90 billion. In this division, the biggest contribution came from Devices and Consumer Licensing segment with revenues of $5.38 billion. But the segment’s revenue, which represents earnings from Windows OEM, consumer Office, Windows Phone and Android royalties, dropped 5.6% from same period of last year.
On the other hand, the Devices and Consumer Hardware segment pulled off an impressive performance with 68.4% growth in revenues to $4.72 billion. This growth, which compete offset the declines coming from the Devices and Consumer Licensing segment, was largely driven by the record launch of Xbox-one and an increase in Surface revenues.
The Commercial division also reported double digit growth of 10% to $12.67 billion. The Commercial Licensing Software segment grew by 7% while the Commercial Other segment, which includes cloud and enterprise services businesses, grew by 28% to $1.8 billion.
Biggest Positive
One of the biggest positives in Microsoft’s earnings was its stellar growth in the cloud. The company’s revenues from cloud services increased by a massive 107% from last year to $609 million. A significant portion of this growth can be attributed to Microsoft Office 365 and Azure.
Moreover, not only is the company reporting triple-digit growth numbers here, it has also accelerated this growth. The 107% increase in revenues comes after a 103% increase it reported in the previous quarter.
The cloud services business has the potential to fuel Microsoft’s growth over the next several years. According to research firm Gartner, the market for corporate cloud services is expected to grow by 45% in the current year to $13 billion. Furthermore, the market will likely continue growing at a robust pace in the coming years. This will provide ample growth opportunities to Microsoft.
The company however, will face intense competition from the industry leader Amazon (AMZN, Financial), as well as several other players such as Salesforce (CRM, Financial), Google (GOOG, Financial) and IBM (IBM, Financial).
With the former head of its cloud services segment as the CEO, Microsoft will likely continue growing rapidly in cloud services. Over time, the segment, which is still just a very small part of the tech giant, will become more visible as it grows its cloud services revenues.
Conclusion
As mentioned earlier, Microsoft’s shares have failed to take off, despite a new CEO and solid quarterly results. In the the last three months, Microsoft’s shares have been up just 0.5%.
The investors weren’t really excited with the appointment of the new CEO, particularly since some of the well-known names in the industry, such as Elop and Alan Mullaly, were thought to be in the running. The promotion of an insider to the top, who was largely unknown to the outside world, was considered a safe bet.
Microsoft’s management, however, knows what it is doing. While investors still consider Microsoft as a company that primarily sells Windows, MS Office and Xbox, the company has realized that the future of computing lies in the cloud and its integration with enterprise products and services.
Microsoft sees significant room for growth in this area where it offers products such as Azure, Dynamics, SQL Server and others. Satya Nadella’s appointment at the top confirms that Microsoft’s priority is the growth of its cloud services business, which has not only grown quickly but is also considerably more profitable than its other operations. This could be great for the company in the long run as robust growth in cloud can make up for the sluggish growth in other areas while the company could also improve its profitability.
Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.
