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The Science of Hitting
The Science of Hitting
Articles (656) 

Microsoft: Strength Amid Uncertainty

A look at the company's 3rd-quarter financial results

May 03, 2020 | About:

Microsoft Corp. (NASDAQ:MSFT) reported financial results on Wednesday for the third quarter of fiscal 2020 – and it was another period of solid results for the company in the face of global economic uncertainty. Revenue grew 15% to $35 billion, driven by year-over-year growth in each of the three business segments. Operating income grew at a faster pace due to continued margin expansion (up 320 basis points year over year to 37%), with net income and diluted earnings per share both increasing by more than 20% (diluted EPS up 27% in constant currencies).

Commercial Cloud revenues (Office 365 Commercial, Azure, Dynamics 365 and LinkedIn Commercial) were $13.3 billion, up 39% year over year. Run rate Commercial Cloud revenues now exceed $53 billion – roughly three times higher than the level at the end of fiscal 2017.

In addition to significant revenue growth, the commercial cloud business continues to benefit from economies of scale and increasing mix shift toward premium services, with gross margins up 400 basis points to 67% (“significant improvement in Azure gross margins”). As a result, gross profit dollars for Commercial Cloud increased by nearly 50% to $8.9 billion.

Digging into the segment results, Productivity & Business Processes revenues increased 16% (constant currency) to $11.7 billion. Customer growth continued for Office 365 Commercial (20% seat growth to nearly 260 million active users) with higher average revenue per user from continued mix shift improvements (“strong upsell to E5”), leading to a 27% increase in constant currency revenues. Office 365 Consumer continued to report strong growth as well, with nearly 40 million subs at quarter end (up mid-teens year over year).

Dynamics reported another quarter of healthy revenue growth (up 20% in constant currencies), with Dynamics 365 growing by nearly 50% year over year. Finally, LinkedIn revenue increased by more than 20%, with strength throughout much of the quarter from user growth and higher engagement offset by a slowdown in advertising spend in March as a result of Covid-19.

In addition to mid-teens revenue growth, Productivity & Business Processes operating margins expanded 200 basis points in the quarter; as a result, segment operating income increased 20% to $4.8 billion, with year-to-date operating income for the segment up 24% to $14.8 billion.

Intelligent Cloud revenues were $12.3 billion (up 29% in constant currencies), with another quarter of outsized contribution from Azure (up 61%). As shown below, recent results in the Intelligent Cloud business segment have held at +25% to +30% growth despite more difficult comparisons.

In More Personal Computing, revenue increased 4% to $11 billion, with the segment experiencing a mix of headwinds (search advertising) and tailwinds (gaming) from Covid-19.

Year to date, cash flow from operations at Microsoft has increased 16% to $42 billion. Notable outlays over the same period include $10.7 billion for capital expenditures, $870 million for acquisitions, $11.3 billion for dividends and $17.2 billion for repurchases (the share count has declined 1% over the past year). Microsoft held roughly $71 billion of net cash on the balance sheet at quarter end (roughly $9 per share). It is generating tens of billions of dollars in free cash flow a year and continues to struggle with how to allocate that capital expeditiously (for what it’s worth, the company spent $7 billion on repurchases in the third quarter, compared to $5 billion on average in the first two quarters of the fiscal year). Much like its large-cap tech peers, Microsoft’s balance sheet positioning continues to be conservative. As Covid-19 impacts many businesses in the months and quarters ahead, and potentially Microsoft’s own stock price, we’ll see if the company is able to take advantage of some of the opportunities that may arise.

Conclusion

The pandemic, which has impacted individuals and businesses alike, is an opportunity for Microsoft to help customers navigate through unprecedented uncertainty. Here’s CEO Satya Nadella:

“As COVID-19 impacts every aspect of our work and life, we have seen two years' worth of digital transformation in two months. From remote teamwork and learning, to sales and customer service, to critical cloud infrastructure and security, we are working alongside customers every day to help them stay open for business in a world of remote everything. There is both immediate surge demand, and systemic, structural changes across all of our solution areas that will define the way we live and work going forward. Our diverse portfolio, durable business models and differentiated technology stack across the cloud and the edge position us well for what's ahead.”

I think Microsoft continues to offer a near unparalled combination of long-term growth prospects in its addressable markets, best in class management and financial (balance sheet) strength. But I would also argue that those considerations are largely accounted for in the valuation.

While I continue to be optimistic about Microsoft’s business over the next decade, I’m less confident on what that means for the stock (the returns shareholders should expect over the same period).

I continue to own a sizable position in the company, but would be willing to change that at the right price (something I discussed in February). We’re not there yet, so I’ll keep waiting.

Disclosure: Long Microsoft.

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About the author:

The Science of Hitting
I desire to own high-quality businesses for the long-term. In the words of Charlie Munger, my preferred approach is "patience followed by pretty aggressive conduct." I run a concentrated portfolio, with the top five positions accounting for the majority of its value. In the eyes of a businessman, I believe this is sufficient diversification.

Rating: 5.0/5 (7 votes)

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Comments

BEL-AIR
BEL-AIR - 1 month ago    Report SPAM

I have a question for you science, I just don't understand it, what does msft have $137 billion cash that they have in bonds getting zero intrest, while at the same time they are paying 5% to 6.5% intrest on the $62 billion dollar debt they are holding. If they paid that debt off, it would be like they were getting 6% on the world's highest risk free paying bond.

Same thing can be said of apple and Berkshire Hathaway as well. Berkshire has $137 billion cash getting zero percent in short term bonds, but $100 billion long term debt they are paying maybe paying 6.5% on...

I do not understand, in my business I have no debt and never have since I have huge cash researves, why would I pay 6.5% on debt when I have so much cash and not know what to do with it. So why on earth is apple, msft and Berkshire paying intrest on there debt then when they have hundreads of billions of cash they not know what to do with, seems to me bad managemnt skills.

On these 3 companies alone if they paid off there debt they could save 16 billion a year on intrest related charges from now till entirnity, thats alot of money they are lossing compounded yearly over that length of time of forever.

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