To The Moon

Microsoft Corp (MSFT) develops, manufactures, licenses, & supports a wide range of software products. It has transformed from a component driven (PC, server) to one driven by the need for cloud capacity. Its Azure platform is thriving & is placed 2nd in public cloud in terms of market share. MSFT has three businesses - Productivity & Business Processes (Office, LinkedIn, Dynamics), Intelligent Cloud (Server Products & Cloud Services, Azure, and Enterprise Services) & More Personal Computing (Windows, Devices, Gaming, Search).

Investment Overview

MSFT is the market leader in productivity software market. With a market share of 85% in productivity software, MSFT enjoys certain key competitive advantages over its peers. This is due to its industry-leading product range, widespread market presence and deep C-level relationships. According to ResearchAndMarkets.com, the global productivity software market is predicted to expand at a 14% CAGR over 2022-2026 to US$98bn while during the same period, cloud-based office productivity software market is expected to grow at a 25% CAGR to US$51bn by 2026. Consensus forecast revenue CAGR of 10.3% over FY23-26 for MSFT’s productivity and business process segment which includes (Office, LinkedIn, Dynamics).

Azure is the key growth driver although weak macro may moderate near-term growth. Consensus expects Azure to deliver CAGR of 16.4% over FY23F-26F, reaching US$138bn revenue in FY26F, rising from 38% of group revenue in FY22 to 46% in FY26F. MSFT holds 21% market share (AMZN 32%) in the cloud services. Operating margin for cloud stood at 43% in FY22 vs 35% margin in the PC segment (30% of group revenue). So, MSFT is likely to see an uplift in its margins when customers switch from its on-premises install bases (e.g.: Windows and Gaming) to its cloud platform. However, in 2Q23 Azure revenue grew 31% y-o-y, but a drop from 35% y-o-y growth in 1Q23. Growth in Azure continued to moderate, and higher energy costs are impacting the gross margin. Management indicated a drop of 4%-5% growth in 3Q23 for Azure. Hence, there can be tactical weaknesses in business during the near term due to weaker macro environment, however on the long term the growth looks resilient.

MSFT eyes a bigger pie in ad market with AI powered search engine but declining PC shipment is a near term worry. Revenue from personal computing segment which includes Windows, Xbox, Surface and advertising from the Bing search engine continues to drop. Sales of Windows licenses dropped 39% y-o-y in 2Q23 due to decline in PC shipments (-12.8% in 2022-IDC). MSFT announced a new AI powered copilot for the web on Bing and Edge. According to eMarketer, Digital advertising market was US$570bn in FY22, of which 40% was search advertising and the ad market is expected to grow at a CAGR of 10% over FY22-26F. MSFT noted that for every one point of share gain in the search advertising market, it’s a US$2bn revenue opportunity. Currently MSFT’s market share in advertising is less than 3% (GOOGL 30%) and is expected to increase with usage.

Enterprise application spending is cyclical, given the more discretionary nature of applications projects. During an economic slowdown, when firms are faced with shrinking IT budgets, projects involving application upgrades, migrations or new installations are often deferred. This could present a higher degree of risk for Microsoft, in the event of an economic slowdown. Slower-than-expected commercial cloud growth, slowing cloud spend, foreign currency risk, negative economic conditions, inability to hire, increasing competition, and PC or Server market decelerate faster than expected are also some downside risks for MSFT.

Price looks to be a little elevated at the moment for my liking. While the stock fundamentals are good, I am still cautious at this stage due to the Fed hikes.

@TigerStars 

DYODD