According to a well-known adage, the proof of the pudding is in the eating. Microsoft (MSFT, Financial) finds the pudding particularly tasty right now as it reaps huge rewards from its big and risky bet on cloud services computing.
The company just released its fourth-quarter earnings, and the numbers unmistakably indicate that CEO Satya Nadella’s strategic decision to anchor Microsoft’s growth on enlarging its cloud computing business is beginning to pay off handsomely.
Microsoft has exceeded $100 billion in revenue for the first time in its history.
Revenue from its cloud services division was $9.6 billion for the quarter ending June 30. That was an increase of 23% from the same period last year. Operating margins for the cloud computing unit rose to an enviable 41%, compared with the prior year’s 37%.
It has been a long journey for Microsoft. After 2000, Microsoft stock followed the predictable path of growth companies that had entered their mature stages. From 2000 through 2012, the price of the stock was mostly flat, trading in a narrow range, which reflected a company with a stable and reliable earnings history. In short, the heady days as a high-tech growth stock were behind it.
But with a new CEO came a resurrection.
Since joining the company in 2013, Nadella has made entry into cloud software services a focus of his strategic business plans for the company. He has taken a bland, uninspiring company and repositioned it into a player in the virtual customized database business. He bet the farm on the growth of customized cloud computing services, and the bet paid off.
Since 2013, the price of Microsoft stock has nearly tripled, from approximated $27 in January 2013 to its July 24 closing price of $107.83. This impressive rise is matched by full-year revenue growth of 50% in 2016 and 44% in 2017. Microsoft is already up 22% this year, compared to the S&P 500's computing services sector’s 18% rise.
Microsoft has successfully parlayed its existing base of customers who have been using the company’s office suite and server-related software and converted them to cloud services clients. The company's operating margins helped mitigate some of the financial burden involved with upfront costs associated with acquiring artificial intelligence capabilities that can handle network capacity and demands placed on the system by its growing roster of customers.
Microsoft is investing in capital expenditures to help it compete with its principal cloud computing rivals, Amazon (AMZN, Financial) and Alphabet's Google (GOOGL, Financial). The company spent a record $4 billion in capital expenditures for the quarter and the year-to-date figure is $11.6 billion, versus the $8.6 billion spent last year.
Microsoft’s cloud services growth is also facilitated by the fact that many small-to-medium-sized retailers who have used Amazon’s AWS services realized there was no reason to continue to line the pockets of a company that is driving many of them out of business. Indeed, a recent Goldman Sachs poll revealed that Microsoft is tied with Amazon’s AWS division in terms of which cloud computing provider chief investment officers anticipate using three years from now.
This bodes well for Microsoft and its ability to position itself in the cloud services market as a viable alternative to AWS. Although Microsoft’s strategic plan is to peg future growth on cloud services to replace its one-time prominence as a legacy software company, its corporate Office 365 unit produced healthy revenues in its own right that helped contribute to the company’s overall earnings per share increase. Revenue from its Office productivity suite unit experienced a healthy 13% increase to $9.6 billion. Its online Office 365 corporate productivity suite of services climbed a robust 38%.
Microsoft’s continued earnings growth is contingent on its success in selling its cloud computing platform. At present, both Google and Amazon derive a significant portion of their revenue from advertising (Google) and online retail sales (Amazon).
Although Microsoft sells at only 24 times forward earnings compared to Amazon’s astronomical 230, the price-earnings ratio comparison is a bit skewed.
Amazon’s multiple is not based entirely on its AWS division alone — profitable as it may be — but on its astounding growth in online retail. Most investors are pricing the stock based on continued and uninterrupted stellar growth in the retail and other areas unrelated to AWS. This could prove somewhat precarious should Amazon fail to maintain its overall earnings growth momentum.
It should be noted as well that Microsoft isn’t competing with Amazon’s retail unit, only its cloud database division, and it has made great strides in its quest to be a dominant player in this market.
Disclosure: I have no positions in any of the securities referenced in this article.
