Office 365 has been one of Microsoft’s biggest successes in the last three years, with consumer subscriptions growing from less than a million in 2013, to 23.1 million in the recent quarter and Office 365 commercial seats growing by 45%.
To explain the importance of how Office 365 is helping the company’s future prospects, we need to look a bit deeper into their segment numbers. Microsoft reports revenue numbers using three segments: Productivity and Business Processes, Intelligent Cloud and More Personal Computing. For investors who are confused by this change in reporting, let’s just say it is a smart way for Microsoft to couple its declining legacy business units with more forward-looking, growing business units.
Productivity and Business Processes
The one that we are going to be looking at is the first of these - Productivity and Business Processes. This is how Microsoft breaks out the components of this segment and the declining business in this case is volume licensing of Office products.
“Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:
| Â | • | Â | Office Commercial, including volume licensing and subscriptions to Office 365 commercial for products and services such as Office, Exchange, SharePoint, and Skype for Business, and related Client Access Licenses (“CALs”). |
| Â | • | Â | Office Consumer, including Office sold through retail or through an Office 365 consumer subscription, and Office Consumer Services, including Skype, Outlook.com, and OneDrive. |
| Â | • | Â | Dynamics business solutions, including Dynamics ERP products, Dynamics CRM on-premises, and Dynamics CRM Online.” |
In essence, this segment includes Office Commercial, Office Consumer and Microsoft Dynamics. To put it simply, Microsoft has all of its online products other than Windows here, such as Office 365, Skype, Outlook, SharePoint and Exchange.
Segment Performance
Segment revenue for Ă‚ the fourth quarter increased 5% or $308 million over last year. Of that increase, $249 million was accounted for by Office 365 commercial revenues. For the full fiscal 2016, the segment reported total sales of $26.487 billion, which is a flat figure year-over-year because they posted $26.43 billion for the previous fiscal. Although commercial revenues from Office 365 grew by $135 million over the fiscal, consumer revenue decreased by $69 million.
As more users take the subscription option, volume licensing is obviously taking a hit. What the net gain shows us, however, is that this segment is now a sustainable unit because subscription growth has overtaken licensing losses.
Though Office commercial products and cloud services grew by 5% during the fourth quarter, the important takeaway here is that Office 365 commercial revenues grew by 59% compared to the same quarter last year. For the first three quarters of fiscal 2016, the year-over-year revenue growth figures were 70%, 70% and 63%.
The Investment Angle
The key point to note here is that all of these services are delivered over the cloud and that is the only way tech companies today can create user engagement in a world where penetration for most services is extremely high in developed markets.
The growth of Office 365 alone will become a big booster for other products, such as cloud infrastructure and other cloud-based services, that the user can then opt into with just a click of the mouse. The way things are going for Office 365, this may be the kind of user conduit that Microsoft has been looking for on the commercial side of their business.
The company has also been busy porting customers from rival applications to Office 365. They recently signed up Facebook, Carvajal and World Bank.
“We knew we needed to make a change, and in 2015, we chose to migrate to Microsoft Office 365 and completed our migration successfully with help from Microsoft Services Premier Support.
There are plenty of reasons why we’re pleased that we adopted Office 365, most of which relate to companywide collaboration and efficiency. We appreciate that now we’re able to extend the number of attendees on our video calls using Skype for Business, because greater employee input gives us the opportunity to make more informed decisions.
We also plan to expand use of our Yammer corporate social network to make it simple for all our business divisions to share best practices, comment on projects and tap into the company’s full knowledge base for fast answers to problems.”
-Jaime Parra Mutis, corporate IT director at Carvajal.
For a tech investor, this is as good as it gets - a company with top-heavy legacy businesses that are bleeding money and a suite of new offerings that are slowly catching up to them in terms of revenue contribution. That is the kind of strong tech company that I would want to invest in.
Disclosure: I have no positions in any stocks mentioned and no plans to initiate any positions within the next 72 hours.
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