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Microsoft: A Compelling Case of Business Diversity and Healthy Financials!

July 06, 2014 | About:
Riddhi Kharkia

Riddhi Kharkia

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Evaluating investment proposition in a company can be daunting task, when one is considering a company like Microsoft (MSFT). The difficulty arises from the business structure as many business verticals are housed within one entity. The first click one would associate with Microsoft is how the company’s future is gloomy because of the declining PC sales. But behind this hype, one should not overlook the other businesses the company is operating in and their contribution to the company’s gross operating margin. The company’s diversification strategy is evident from its massive investment in building its cloud strength to boosting the sales of Xbox one console by promoting various games. Also, the induction of Mr Satya Nadella as the CEO has had its share of impact on the price of Microsoft.

Windows 8.1

One of the biggest arguments against Microsoft has been the poor performance of Windows 8 coupled with declining PC sales. The company tried to replicate Apple’s model by developing a uniform platform across tablets, PCs and smartphones. But the new product was unable to create the hype like its earlier peers. The radical change across the software was not taken positively by the customers accustomed to the earlier standard Microsoft features. One of the biggest complaints was the absence of the famous Windows Start button in the home screen. The company was quick to read the market’s feedback and correct its mistake by offering the previous version of Windows 7. Speaking in Microsoft’s favours, this was its first major fail and its engineering prowess can never be ignored. Months later, Microsoft has now come with an updated version of Windows called Windows Blue update. Windows Blue or 8.1 streamlines much of the interface, while adding many cosmetic and tangible, utilitarian features. It is expected to revive consumer’s interest in the ailing product.

Other Businesses

Microsoft resembles that student who does not need great marks in one subject because it has performed fairly in ten different subjects. The Xbox, email Web services, Microsoft Office, Skype, the company’s investment in Nook etc. represents the different subjects of this student.

In retail, Microsoft partnered with Best Buy to get into the stores within store model. This implies that Microsoft will now have its brand visible to the targeted electronic shoppers through Best Buy’s 500 stores in US and another 100 in Canada. Instead of opening exclusive outlets like Apple, Microsoft can now capitalise on direct customer exposure without the hefty real estate price and risk associated with self-owned outlets.

On Cloud Nine

A while back Cisco (CSCO) forecasted that cloud traffic as a percentage of total data centre traffic will grow from 39% in 2011 to 64% in 2016. As per Gartner, the public cloud market may jump 18.5% to $131 billion in 2017 from$111 billion. With big enterprises and mid to small sized business coming to cloud, the cloud business has become the new candy for all tech companies. Microsoft is trying to seize this opportunity in a huge way. Microsoft with its unique market position and extensive investment potential is well positioned to tap this opportunity.

Microsoft’s aggressiveness to the cloud sector can be judged from the fact that Microsoft became the third big tech company after Google and Facebook to push its data centre investment to $1 billion or more when it announced the massive investment of nearly $700 million dollars on “Project Mountain “, a data centre in West Des Moines, Iowa. Also the company entered into a strategic partnership with Oracle Corp (ORCL) enabling customers to run Oracle software on Windows Server Hyper-V and Windows Azure.

Further, Oracle will make its Linux software available to Microsoft’s cloud computing customers. This partnership will now allow both the companies to compete with local cloud based software providers by giving Oracle solution capabilities to Windows Azure customers. Windows Azure is Microsoft’s cloud computing platform for building, deploying and managing applications and services through a global network of managed datacentres.

Lumia: A Growth Getter

The other potential revenue earner for Microsoft is its Lumia series smartphone segment manufactured by the Finnish mobile maker Nokia. While Microsoft’s numbers are not even close to the IPhone OS and the Android systems, it has gradually shown a rise in the market share. Windows 8/WP8 platform is still quiet young and does not have the depth its rivals can offer. But the Lumia range because of its impressive hardware and new software is gaining traction and becoming popular. A recent survey has found Microsoft’s Windows phone platform record a healthy 5.6% rise in sales as compared to an increase of 3.8% last year. It has also outdone Blackberry to become the third most selling Operating System.

Concluding with the Valuations

Currently, Microsoft is trading at a forward P/E of around 14.58 as compared to the industry average of around 19.40. Besides the forward P/E, Microsoft’s PEG ratio is also lower than the industry at 2.32 implying a justified valuation in keeping with the expected earnings. Microsoft has a score of opportunities because of its diverse range of operations and hence, the price range of $40-$45 provides and attractive entry point for the investors.

The stock has already rallied around 12 % this year and holds more positives for long term investors. The reason to buy Microsoft lies in its business diversity. Investors taking a position in the stock with a long term horizon are sure to benefit because of the expected materialisation of the growth drivers of the company.

About the author:

Riddhi Kharkia
A practicing Chartered Accountant based out of India. I have keen interest in analyzing tech stocks that are driven by value.

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