Microsoft Corporation - Zacks Investment Research
| Microsoft Corporation |(MSFT – NASDAQ) |$95.82 |
Note: More details to come; changes are highlighted. Except where highlighted no other sections of this report have been updated.
Reason for Report: 3Q18 Flash Update
Prev. Ed.: Apr 16, 2018; Changes in Estimates & News Update
FLASH UPDATE [Earnings update in progress; to follow]
Microsoft Corporation delivered 3Q18 EPS of 95 cents. The figure rallied 35.7% on a y/y basis.
Revenues of $26.82 billion increased almost 15.5% from the year-ago quarter (up 13% in constant currency or cc).
Commercial bookings surged 26% (18% at cc). Commercial unearned revenues were $20.04 billion up 17% y/y at cc. Commercial revenue annuity mix was 89%, up 2 points y/y driven by an increased mix of cloud offerings.
Commercial cloud revenues were $6 billion, up 58% y/y (55% at cc), reflecting solid growth in the United States, Western Europe and the U.K.
Azure, Office 365 Drives Growth
Productivity & Business Processes includes the Office and Dynamics CRM businesses. Revenues jumped 16.9% (up 14% at cc) on a y/y basis to $9 billion.
The Commercial business (products + Office 365 & related cloud services) revenues were up 14% from year-ago level (up 12% cc). Office 365 commercial revenues grew 42% (40% at cc) driven by strong installed base growth and average revenues per user (ARPU) expansion primarily due to customer migration to premium workloads in E3 and E5. Office 365 Commercial seat grew 28% on a y/y basis.
The Consumer business revenues advanced 12% (9% at cc) y/y in the quarter. Office 365 consumer subscribers are now at 30.6 million, while Office 365 commercial now has more than 135 million monthly active users.
Dynamics business grew 17% (14% at cc). Dynamics 365 revenues soared 65% (62% at cc).
Adoption of Teams solution has been impressive, with almost 200K organizations in 181 markets using the solution, including the likes of Maersk and General Motors.
Teams has been enabled for a broad spectrum of calling and meeting room devices. Microsoft is building AI-powered services into Teams and has integrated Microsoft Stream, the company’s enterprise video service, for transcription and time-coding of recorded meetings.
LinkedIn revenues surged 37% from the year-ago quarter (33% at cc) to $1.34 billion. LinkedIn sessions were up more than 30% reflecting acceleration in engagement.
Moreover, engagement across the platform is strong, with 65% y/y growth in jobs, visitors across mobile and desktop, 60% growth in feed update views and nearly 40% growth in messages sent.
Intelligent Cloud includes server as well as enterprise products and services. The segment reported revenues of $7.89 billion, up 17.3% (15% at cc) y/y.
Commercial cloud annualized revenue run rate reached $20.4 billion, achieving company goal set in FY15.
Server product and cloud services revenues went up 20% y/y (up 17% at cc). The high point was Azure revenues, which soared 89% at cc on a y/y basis. Microsoft stated that Azure premium revenues grew triple digits for the 15th consecutive quarter. Data center expansion continues with Azure now in 50 regions globally, more than any other cloud provider.
On-premise server products revenues increased 3% (up 1% at cc) driven by customer demand for hybrid solution as well as increasing virtualization needs.
Enterprise Mobility install base grew 55% y/y to more than 65 million.
Moreover, enterprise service revenues increased 8% (5% at cc) in the reported quarter, due to growth in premier support services and Microsoft consulting services.
Microsoft has been building its forte into cloud security. The company recently announced Microsoft Secure Score attack simulator, and Windows Defender ATP automatic detection and remediation capabilities. The company has also added compliance capability feature into cloud services. The additional features have helped the company win customers like Coca-Cola.
More Personal Computing comprises mainly the Windows, Gaming, Devices and Search businesses. Revenues were up 13% (11% at CC) y/y to $9.92 billion. Excluding phone business, revenues grew 3%.
Windows OEM pro revenues increased 11% on a y/y basis. Windows OEM revenues increased 4% (same at cc). Moreover, windows commercial products and cloud services revenues increased 21% on a y/y basis (17% at cc) driven by higher volume of multi-year agreements.
Windows 10 Commercial monthly active devices grew 79% y/y.
Gaming revenues increased 18% (16% at cc) driven by robust performance from Xbox software and services (up 21% at cc). Xbox Live monthly active users were up 13% to 59 million active users.
Surface revenues surged 32% (27% at cc) from the year-ago quarter.
Search advertising revenues excluding traffic acquisition costs (TAC) revenues grew 16% (14% at cc) as both search volume and revenues per search (RPS) improved.
Operating Results
Microsoft’s gross margin of 65.4% expanded 2 points from the year-ago quarter, primarily owing to growth in Productivity & Business Process segment partially offset by weak Intelligent Cloud.
Productivity & Business Process gross margin increased due to improvements in Office 365 and LinkedIn. However, Intelligent Cloud segment gross margin declined owing to higher mix of cloud offerings, partially mitigated by solid improvement in Azure gross margin. More Personal Computing gross margin remained unchanged y/y.
Commercial cloud gross margin was 57%, up 6 points y/y due to improvement across Azure, Office 365 and Dynamics 365.
Operating expenses of $9.26 billion were up 9.8% (up 8% at cc) from the year-ago quarter driven by higher investments in commercial sales capacity, cloud engineering and LinkedIn. As percentage of revenues, operating expenses decreased 180 basis points (bps) from the year-ago quarter.
As a result, operating margin expanded 200 bps on a y/y basis to 30.9%.
Productivity & Business Process operating income grew 23% (up 19% at cc). Intelligent Cloud operating income increased 24% (up 21% at cc). More Personal Computing operating income increased 24% (up 20% at cc).
Balance Sheet
Microsoft ended with cash and short-term investments balance of $138.5 billion, up $5.5 billion from the previous quarter.
Free cash flow increased 3% y/y to $9.2 billion, primarily attributable to higher collections from customers following billings growth.
The company returned $6.3 billion to shareholders in the form of share repurchases and dividends in the reported quarter.
Guidance
For 4Q18, Microsoft anticipates foreign exchange to increase revenues growth by 3 points, COGS by 1 point and operating expenses by 1 point.
Management expects strong performance from the commercial business. Commercial unearned revenues are expected to increase 38–39% sequentially.
Commercial cloud gross margin is projected to remain flat sequentially.
Productivity and Business Processes revenues are expected between $9.55 billion and $9.75 billion. Office 365 commercial growth is anticipated to normalize. Dynamics revenue is expected to grow double digit, driven by the ongoing shift to Dynamics 365. LinkedIn growth is envisioned to remain strong.
Intelligent Cloud revenues are projected between $8.95 billion and $9.15 billion, with another quarter of high-teens revenue growth across server products and cloud services. Management expects Azure revenue growth to reflect strength in infrastructure, data and application services, and moderating growth in Microsoft’s per user-based services like EMS.
More Personal Computing revenues are anticipated between $10.3 billion and $10.6 billion. Windows OEM Pro and non-Pro revenues should track roughly in-line with the 3Q18 results.
Surface revenues expected to be up in the high teens, as the transition to the new products continues. Management expects mid-teens revenues growth in search ex-TAC.
Gaming revenues are anticipated to grow at a higher rate due to benefits from third-party game title performance and improving user engagement.
Microsoft expects COGS in the range of $9.6-$9.8 billion and operating expenses in the range of $9.8-$9.9 billion.
Management expects effective tax rate to be roughly 16% for 4Q18.
Microsoft provided some perspectives for FY19. Continuing transition to cloud services is expected to drive top-line growth. Microsoft’s unique position as a hybrid cloud solution provider is expected to drive server products and cloud services revenues.
Office 365, Dynamics 365, and LinkedIn will also continue to drive double-digit revenue growth in Productivity and Business Process segment.
Moreover, gross margin percentage of commercial cloud service will continue to improve driven by increasing consumption of Azure IaaS and PaaS. Management anticipates revenue mix shift to Azure to moderate commercial cloud gross margin growth rate.
Finally, Microsoft expects effective tax rate to be slightly below the new U.S. corporate tax rate of 21% for FY19.
Portfolio Manager Executive Summary [NOTE: Only highlighted material has been changed]
Microsoft Corporation (MSFT) is a software developer of consumer and business applications and services. Azure, Windows operating system (OS) and Office 365 constitute the company’s most successful products. On Dec 8, 2016, the company completed acquisition of LinkedIn, the world’s largest professional network on the Internet. Total revenue was $96.66 billion in FY17. The company ended the year with $15 billion in commercial cloud revenue.
Competition: Microsoft’s presence in many segments of the technology sector exposes the company to a multitude of competitors. It faces cutthroat competition not only from traditional software companies such as SAP, Oracle and IBM, but also from companies such as Apple, Google and Facebook in the areas of OS/smartphones/tablets, Internet search and Social Media (post LinkedIn acquisition).
Firms’ Opinions: Of the 27 firms in the Digest group covering the stock, 21 provided positive ratings, four gave neutral ratings and two had a negative outlook. Target prices range from a low of $62.00 to a high of $130.00, with the average being $102.30. The expected return over the current share price provided by the firms is 8.6%.
Positive (Buy or equivalent outlook) – 21 firms or 77.8% – These firms believe that Microsoft’s dominant market position, large total addressable markets (TAMs), strong momentum in the cloud services business and solid dividend yield are major growth drivers. They believe that the company is reshaping business model for the cloud, artificial intelligence (AI) and edge computing. The firms believe that based on the Azure Stack, the company is well positioned to become a dominant hybrid cloud provider in the long haul. Moreover, the company’s continuing investments in expanding product portfolio and sales capacity is appreciable. Additionally, the company’s focus on enhancing operational execution and improvements in cloud margins will help in margin expansion. Most of these firms believe that strong commercial cloud top-line growth, gross margin expansion, efficient expansion management, solid execution and robust cash flow generation ability will drive growth in the next several quarters.
Neutral (Neutral or equivalent outlook) – 4 firms or 14.8%
Negative (Sell or equivalent outlook) – 2 firms or 7.4% – The firms are concerned about sluggish growth in the PC market, which will hurt Windows revenues, eventually affecting top-line growth over the long term.
General Outlook on Microsoft: With strong fundamentals and exposure to diverse markets, Microsoft possesses all the qualities of a defensive growth story that is attractive in turbulent markets. While the firms believe that the PC market will be volatile in the near term, the cloud segment will prove to be a positive for the company.
Apr 16, 2018
Overview [NOTE: Only highlighted material has been changed]
Redmond, WA-based Microsoft Corporation is one of the largest broad-based technology providers in the world today. Although software is the most important revenue source, the company’s offerings also include hardware and online services. Additionally, Microsoft offers support services in the form of consultation, training and certification of system integrators and developers.
Microsoft reports financial performance under three segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.
Productivity & Business Processes (31.5% of fiscal 2017 revenues) includes the Office and Dynamics CRM businesses. Office 365 Consumer subscribers increased to 27 million at the end of fiscal 2017.
Intelligent Cloud (28.4% of fiscal 2017 revenues) includes server, enterprise products and services. At the end of fiscal 2017, commercial cloud annualized revenue run rate exceeded $18.9 billion.
More Personal Computing (40.1% of fiscal 2017 revenues) comprises mainly the Windows, Gaming, Devices and Search businesses. At the end of fiscal 2017, Xbox Live monthly active users were 53 million.
On Jul 1, 2017, Microsoft adopted ASC 606 and 842 standards. Under the ASC 606 standard, software license revenues need to be recognized up front. Revenues related to ongoing obligations, such as updates and maintenance, is deferred and recognized ratably over the term of the service contract.
The 842 standard will drive a change on the balance sheet, with the addition of new line items called operating lease right-of-use assets and operating lease liabilities. Specifically, operating leases for datacenters, offices, R&D facilities, retail stores and other equipment will be reported on the balance sheet, providing investors with enhanced transparency around Microsoft’s lease-related assets and liabilities. This resulted in a net increase in assets and liabilities of $6.6 billion as of Jun 30, 2017 and $5.2 billion as of Jun 30, 2016.
The firms have identified the following key issues for evaluating the investment merits of Microsoft:
| Key Positive Arguments | Key Negative Arguments |
|Cloud Adoptions – Microsoft’s Azure is fast closing in on Amazon’s AWS. |Stiff Competition – Microsoft faces stiff competition on multiple fronts |
|The company is well positioned to beat competition and become the |– from Amazon in the cloud computing market, Google in the Internet |
|dominant hybrid cloud provider. |content/advertising/search sectors, Sony in the video game console, and |
| |from major technology companies that have embraced the Linux OS. |
|Windows Opportunity – The latest Windows versions are compatible with | |
|both PCs and mobiles, which translate to a huge opportunity. |Weak PC Demand – Global decline in PC demand is adversely affecting |
| |Microsoft. |
|SaaS Share – Microsoft is gaining share in the enterprise | |
|software-as-a-service (SaaS) market through deeper integrations within | |
|its Dynamics, Analytics and Office 365 offerings. | |
| | |
|LinkedIn Opportunity – The LinkedIn acquisition will not only help | |
|Microsoft to explore opportunities in its business software market, but | |
|will also strengthen its position in professional social media market. | |
| | |
|Strong Balance Sheet – Improving liquidity enables Microsoft to generate | |
|value for shareholders as well as pursue accretive acquisitions. | |
More information is available at .
Note: Microsoft’s fiscal year ends on Jun 30.
Feb 22, 2018
Long-Term Growth [NOTE: Only highlighted material has been changed]
Long-term EPS growth for Microsoft is projected to be 11.9%.
Microsoft expects the cloud strategy to help extend new products and services to its existing and new customers. Moreover, cloud services will enable the company to improve customer experience, which should increase recurring revenues and lower support costs. Microsoft’s revenue opportunities in cloud computing are attractive, but the margin structure is still unclear.
Most of the firms believe that the cloud holds significant opportunities for Microsoft going forward. The firms expect that Microsoft will be in a better position to grow in the cloud business as it increases its marketing efforts and customer and partnership adoption accelerates.
The bullish firms believe the long-term outlook for Microsoft's core businesses of Windows, Office and Server remains healthy over the next few years. Windows 10 represents a pivotal transition for Microsoft, one which should provide flexibility and allow it to extend the Windows franchise to the fast-growing mobile platform and thus bring about long-term growth. Microsoft remains a dominant player in the enterprise-focused hybrid cloud technology.
Feb 22, 2018
Target Price/Valuation [NOTE: Only highlighted material has been changed]
Provided below is a summary of target price and valuation as compiled by Zacks Research Digest:
|Rating Distribution |
|Positive |77.8% |
|Neutral |14.8% |
|Negative |7.4% |
|Average Target Price |$102.30↑ |
|Digest High |$130.00↑ |
|Digest Low |$62.00 |
|Firms with Target Price/Total |23/27 |
Risks to the target price include currency fluctuations, possible political or economic instability, change in customer expectations and nature of demand, margin pressure, unfavorable trends in emerging markets, escalating operating costs, barriers to international expansion, competition from sponsored search vendors, fraud, risks associated with patent litigations, slowdown in consumer spending due to geopolitical and macroeconomic uncertainties, failure of new products to meet expectations, a long-term shift away from Microsoft products, and execution risk during the leadership transition.
Recent Events [NOTE: Only highlighted material has been changed]
On Apr 16, 2018, Microsoft announced several new intelligent security tools and technologies to help enterprises secure their data and networks more easily. The new tools include Azure Sphere, a platform for creating highly secured, connected MCU devices on the intelligent edge. The company also introduced several new intelligent security features for its Microsoft 365 commercial cloud offerings designed to help IT and security professionals.
On Apr 10, 2018, Microsoft and C3 IoT announced a collaboration to deploy new technology developments and improvise go-to-market initiatives. The aim is to arrive to a “better together” solution which accelerates enterprise Artificial Intelligence (AI) and Internet of Things (IoT) application development.
On Mar 26, 2018, Microsoft shares were buoyed by Morgan Stanley’s note stating that the company’s impressive cloud adoption will lead it to a market capitalization of $1 trillion within the next 12 months.
On Feb 28, 2018, Microsoft and Sunseap Group inked a deal that marks Microsoft's first clean energy deal in Asia to create the single-largest solar energy portfolio in Singapore.
On Feb 22, 2018, Microsoft Corp. and Compuverde announced they have entered into a license agreement to enable access to Microsoft’s Server Message Block (SMB) file transport technology for latter's software-defined storage (SDS) solution.
On Feb 21, 2018, Microsoft and Qualcomm jointly announced that leading retailers from across the world will offer a range of new Microsoft Always Connected Windows 10 PCs powered by the Qualcomm Snapdragon Mobile PC Platform.
On Feb 15, 2018, Microsoft and Flyreel announced a working relationship to accelerate access to the latter's exclusive underwriting assistant. Per the deal, Microsoft is investing resources and expertise to accelerate Flyreel's go-to-market strategy, bringing new efficiency and accuracy to the property and casualty insurance market.
On Jan 31, 2018, Microsoft announced fiscal 2Q18 results. Highlights are as follows:
• Revenues increased 12% y/y to $28.92 billion.
• EPS was 96 cents, up 20% y/y.
• Cash and short-term investments balance of $142.8 billion, up $4.3 billion q/q.
• Microsoft returned $5 billion to shareholders in the form of share repurchases and dividends.
On Jan 30, 2018, Columbia Sportswear Co. and Microsoft announced plans to collaborate on enhancing Columbia Sportswear's global consumer experience and drive its digital transformation using intelligent cloud technology. Columbia Sportswear also plans to use Dynamics 365 and Azure to gain greater consumer insights and business intelligence through every consumer interaction.
On Dec 13, 2017, Microsoft launched new features on its Bing search engine powered by artificial intelligence.
Revenues [NOTE: Only highlighted material has been changed]
According to 2Q18 press release, revenues of $28.92 billion increased almost 12% from the year-ago quarter (up 11% in constant currency or cc). Revenues were positively impacted primarily due to strategic growth investments in cloud business and Artificial Intelligence (“AI”) along with robust sales implementation. LinkedIn contributed 4 points of revenue growth.
Microsoft stated that better-than-expected performance in large markets like France, the United States and Western Europe drove top-line growth.
Commercial unearned revenues were $20.2 billion, up 18.1% y/y and marginally higher than Microsoft’s expectation, primarily owing to strong customer commitments to Azure and FX benefit.
Annuity mix was 86%, while commercial bookings grew 7% (4% at cc). New Commercial cloud business revenues were approximately $5.3 billion, growing 56% y/y.
Provided below is a summary of revenue as compiled by Zacks Research Digest:
|Revenues ($ in Millions) |2Q17A |
|Copy Editor | |
|Content Ed. | |
|Lead Analyst |Awantika Poddar |
|Reason for Update |3Q18 Flash Update |
| | |
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April 27, 2018
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