As we all know, Microsoft (MSFT) is a world-famous company. The company's bet on cloud computing has fueled its growth and made Microsoft a market leader in key technology areas. The company offers a wide range of software-as-a-service (SaaS) and infrastructure-as-a-service (IaaS) offerings. The pandemic has moved the world further to the cloud, normalizing remote work, digital capabilities, distance learning, and the industry's transition from offline to online.
Microsoft appointed Satya Nadella as CEO in 2014 because his experience as Microsoft's executive vice president of cloud and enterprise groups made him the right person to lead Microsoft to its goal of being a cloud leader.
The company's Azure business unit has been growing at a staggering 50% year-over-year growth rate. Microsoft is the preferred provider for companies looking to operate in a hybrid environment, and today it is now generally second only to Amazon's Amazon Cloud Web Services (NASDAQ: AMZN). The growth space in the industry is enormous, and Microsoft, with its scale and technology, is well positioned to seize future opportunities.
Cloud applications are eating into the software market
Tech investors have been tracking FAANG's stock for years and seeing it as a leader in the tech industry. However, the advent of the cloud gave birth to Microsoft's MT SAAS Group, Twilio (TWLO), Shopify (SHOP), Amazon (AMZN), Adobe (ADBE), and Salesforce (CRM).
Ten years ago, Marc Andreessen concluded that "software is eating the world," and over the years his assessments seemed increasingly prescient. Today, it can also be said that cloud computing is eating away at software, with projections estimating that by 2025, cloud computing will account for the majority of enterprise software and will account for the vast majority by 2030. In fact, cloud computing is not just eating away at software, it is also swallowing up the market share of hardware and related services, which is a big trend now and in the future.
Since its inception in 2013, the Bessemer-Nasdaq Emerging Cloud Index (EMCLOUD) has grown at an astonishing rate and demonstrated the importance of the cloud to the global economy:
Source: Bessemer Venture Partners
On the 2020 earnings call, Nadella claimed that Microsoft had foreseen that "we saw two years of digital transformation in two months." Since then, the cloud applications market has continued to grow.
According to Gartner, the total market capitalization of the global public cloud will exceed $480 billion by the end of 2022, continuing to expand from $314 billion in 2020. Gartner estimates that the IaaS industry will grow by more than 30 percent by 2022 to reach a market value of nearly $121 billion. SaaS is expected to grow by more than 18 percent to about $172 billion. Microsoft has also invested in Platform as a Service (PaaS), which Gartner expects to grow by nearly 26 percent to more than $100 billion. All of these are impressive growth projections, and Microsoft is the leader in these markets.
Global Public Cloud Services End-User Spending Forecast (USD mn)
Source: Gartner
The importance of hybrids is underestimated
Change will never be as fast as investors think. Institutional rigidity and other investments in the past could put pressure on companies to change, making fundamental change largely impossible.
Microsoft is one of the oldest great tech companies, which makes it easy for investors to miss out when thinking about future technologies. It is Microsoft's history that gives it a unique advantage over newer cloud computing companies. Considering that many customers are not yet accustomed to moving to the cloud completely, Microsoft understands what older, more mature companies need to do to transform their cloud businesses.
In fact, when Microsoft conducted a survey in 2018, it found that 67 percent of respondents intended to use a hybrid cloud. These enterprises need hybrid solutions to address their concerns about the security and scalability of computer resources. Microsoft found that the most common applications for hybrid cloud are controlling where critical data is stored (71 percent), backups, and disaster recovery of critical information systems (69 percent).
Microsoft is gaining favor with developers
Microsoft's focus on growing Azure gives it a crucial advantage over Amazon Web Services. Amazon Web Services is an industry leader with a more diverse portfolio of businesses, from e-commerce to the cloud. While Amazon Web Services is the leader, its lead has been shrinking over the years as Microsoft's Azure and Google's Google Cloud Platform grow.
In fact, in the Cloud Applications Report 2021, Bessemer Venture Partners believes that Microsoft Azure will surpass Amazon Web Services in two to three years.
Microsoft has made strategic acquisitions, such as GitHub, the world's largest developer project and file repository, suggesting that the company has been focused on dominating cloud infrastructure. Open source will be a key source of innovation in the future, and if successful, Microsoft's embrace of it will help it leapfrog Amazon Web Services.
In fact, Microsoft has contributed millions of projects to GitHub, and by 2016, Microsoft had become the biggest contributor to the platform. The company has already pushed. NET and .NET CORE, which run on microsoft's Windows operating system as well as MacOS and Linux at the same time. Currently, 50% of all Azure core computing is for Linux.
According to Beth Kindig, Microsoft did this because it believed that by attracting developers, it would win the support of key decision makers when choosing the cloud services that businesses would use.
Microsoft is expected to continue to increase shareholder value
In the Q1 financial report of fiscal 2022, Microsoft's performance is remarkable. The company achieved double-digit growth in all but 2 of its 14 product and service divisions. Cloud revenue accounted for 46% of total revenue, up 36% year-over-year to $20.7 billion and total revenue up 22% to $45.3 billion.
According to the company's 2021 annual report, revenue for 2021 was $168 billion, up 17.5 percent from $143 billion in 2020. Microsoft's revenue over the past twelve-month period exceeded $176 billion. For companies of this size, double-digit growth is a testament to Microsoft's success in reconstructing its business model.
Microsoft's net operating profit after tax (NOPAT) was $60.2 billion in 2021, compared to $44.5 billion in 2020. Microsoft is not only growing revenue, but also increasingly profitable. Over the past twelve months, the company has earned $64 billion in NOPAT. Further highlighting the quality of the business is that Microsoft has a very impressive NOPAT margin, with a NOPAT margin of 35.8% in 2021 and 36.3% in the past December.
Between 2017 and 2021, Microsoft's 5-year return on investment (ROIC) was 35.6%. During that time, Microsoft's economic revenue grew from $14.5 billion to more than $52 billion.
The downside of Microsoft's excellent performance is that while it generates significant free cash flow (FCF) — freeing up $34 billion worth over a twelve-month period — it doesn't offer an attractive price. Its corporate value is close to $2.3 trillion, and FCF yields just 1.5 percent.
Microsoft's economic book value (EBV) exceeded $1 trillion, putting it at $141.34 per EBV during the TTM period. The stock is currently trading at around $300, which gives it a PEBV value of 2.2. This tells us that the market expects Microsoft's revenue to grow at a rate of 7.2% over the next 19 years. During this period, Microsoft expects the average economic margin to also reach 44.9% (compared to 39.9% over the past twelve-month period). This indicates a reasonable discrepancy between the Company's historical performance and the Company's expected financial results implied by the price.
The upcoming new financial report, according to Zhitong Finance, the market generally expects the stock's Q2 revenue to grow by nearly 17% to $50.3 billion; Revenue per share rose approximately 12 percent to $2.32.
Among them, the intelligent cloud business is expected to remain the company's highest revenue growth business. Analysts expect revenue growth of 25.5 percent to $18.32 billion, with Azure cloud platform sales up more than 40 percent year-over-year in Q2, and productivity and business processes business and more personal computing business expected to grow 19.2 percent to $15.91 billion and 10.3 percent to $15.12 billion, respectively.
Although the earnings report has not yet been released, there are already market analysts such as Citi, Bank of America, Cowen and other market analysts generally optimistic about Microsoft's prospects.
What do institutions think?
Wade Bush analyst Dan Ives commented, "Based on our recent review, we believe that the company, led by Azure/Office 365, has again achieved strong performance in the December quarter, and we expect revenue to grow by about 3% and rise across the board, which should be for the entire tech industry looking ahead," Ives believes that Microsoft's major cloud deals grew by more than 50%, and as the size of the transaction increases, there is "significant momentum" by 2022.
Source: Extranet
Citi analyst Tyler Radke maintained a "buy" rating on Microsoft, with its price target down to $376 from $407. Radke said Microsoft enterprise customer renewal momentum is strong, especially for products like Office 365 and Dynamics, though the analyst also noted that Azure revenue growth could slow due to seasonally weak bookings last quarter. Meanwhile, Radke lowered its forecast for more personal computing businesses in fiscal 2022 as business PC sales were expected to slow, so the analyst expected Microsoft to earn $9.69 per share in fiscal 2022, down from the previous forecast of $9.73.
Bank of America analyst Brad Sills also maintained a "buy" rating on Microsoft and maintained a price target of $365. Sills said that due to the continued strength of Microsoft's main business, the company's upcoming Q2 revenue is likely to exceed its previous estimate of $50.7 billion. The analyst believes that the Q2 growth rate of the Azure cloud platform will be as high as 49%, higher than the analyst's previous forecast of 46%.
In addition, Q2 revenue from the More Personal Computing business is expected to be $250 million higher than the analyst's previous forecast of $16.6 billion due to increased PC shipments. Sills said the stock remains the best option for investments as the company's free cash flow is likely to continue to grow over the next decade.
Cowen analyst Derrick Wood maintained Microsoft's "outperform" rating and a $360 price target. The analyst agrees with Sills that the market's previous expectations for 45% growth on the Azure cloud platform may have been too low. In addition, the analyst expects strong demand for Office 365 before it rises, and Microsoft's Q2 financial results are expected to be slightly higher than Wall Street's expectations. Wood added that the Azure cloud platform will continue to be a major growth driver for Microsoft in the future, while Office 365 has been a huge success and could become the world's SaaS business (software as a service).
conclusion
Microsoft has a long history and strength. Since Nadella took over, the company has taken a number of key strategic steps to get rid of all obstacles and become a leader in cloud computing. It has succeeded in increasing its own profitability — or in an industry where losses are sometimes seen as a badge of honor. Riding on the megatrend of cloud applications, it is likely to surpass Amazon Web Services and continue to create greater value for shareholders. The biggest risk for investors at the moment is that the market has a correct understanding of Microsoft's unique advantages, and it will not be cheap.