Microsoft's High Valuation Is Justified for These Reasons

The company is positioning itself in a unique niche that none can match

Author's Avatar
Mar 30, 2017
Article's Main Image

Microsoft (MSFT, Financial) is trading around 31 times earnings and six times sales, and for a technology company that posted near-flat revenue growth during the most recent quarter, the valuation seems a bit over the top.

The reason Microsoft has run up quite a bit in the last six months is there is now a lot more clarity around the direction the company is taking as well as strong growth in cloud-based services.

As the company embarked on its cloud journey, many things changed. The Windows maker now looks more cohesive as a company, one with a clear plan to take the enterprise segment in its entirety. Microsoft is on its way to building an enterprise software stack that will be extremely hard for competitors to match.

At its core lies Office 365, Microsoft’s lead productivity application suite, which saw a huge list of new services and features added to it in the last 12 months. Microsoft recently announced that it has nearly 85 million active users on Office 365, a significant milestone along its path to move fully into the SaaS mode of software delivery.

Microsoft already has a strong bundle for office collaboration in Office 365 featuring Skype, Outlook and OneDrive, and the recently launched Microsoft Teams tries to bring all of the different elements under one roof, making it easier for collaborating in the workplace.

As office productivity applications grow from strength to strength, Microsoft is slowly building up its ERP and CRM tool, Dynamics 365. The ERP and CRM market is worth in the tens of billions of dollars and has Salesforce (CRM, Financial) and Oracle (ORCL, Financial) in dominant positions. Microsoft might not be in their league yet, but the company did manage to nab HPÂ (HPQ, Financial) from Salesforce and add it to its own client portfolio.

In the press release announcing the deal, Microsoft noted:

Microsoft Corp. has entered a six-year agreement with HP Inc. to deploy Microsoft Dynamics to thousands of employees across HP, dramatically enhancing collaboration across marketing, sales and service operations. With Dynamics, as well as Azure, Office 365 and other Microsoft Cloud solutions, HP has invested in the sales and service collaboration platform it needs to deliver a seamless sales experience for customers and partners while increasing the company’s performance and economies.”

One major advantage HP gained by selecting Microsoft was that the deal came with everything HP would need to run an efficient workforce. There was the Office 365 bundle for employee collaboration; there was Dynamics 365 to take care of sales and service and Microsoft Azure for backend infrastructure – all under a single roof. No need to worry about multiple integrations and security issues, either, because the vendor itself makes sure that all of its products work together seamlessly and securely.

Another element contributing to Microsoft’s valuation is the looming presence of LinkedIn (LNKD, Financial), the white elephant that might yet turn out to be a cash cow. It purchased the professional network mainly to bolster its position in the CRM market and provide a solid support system for Dynamics 365.

There will be plenty of competition for Microsoft to face. It needs to deal with Salesforce on the CRM front, Oracle in the ERP market, Amazon (AMZN, Financial) for cloud infrastructure, Google for office productivity and so on.

The biggest strength that Microsoft has – one of which no other single company can boast – is the ability to offer nearly all of the software that a company needs to manage internal as well as external operations.

Disclosure: I have no positions in the stocks mentioned above and no intention to initiate positions in the next 72 hours.

Start a free seven-day trial of Premium Membership to GuruFocus.

Become a Premium Member to See This: (Free Trial):

» Take a Free Trial of Premium Membership