|Ticker: MSFT||Nature of Business: Technology Services||Location : USA|
|Recent Price: $255.59||52-Week High/Low: $259.19/166.11||Estimated Fair Value: $149.00-$163.80|
|Expected Return: 10.1%||Consider Buy: Below $163.80||Business Risk: High|
|Financial Risk: Medium||Economic Moat: Wide||Corporate Governance: Strong|
Bill Gates and Paul Allen formed Microsoft Corporation in April 1975. The company develops and markets software such as Microsoft Windows and Microsoft Office. It also deals in devices, including personal computers, tablets, gaming and entertainment consoles. MICROSOFT trades on the Nasdaq Stock Exchange in the United States of America (USA) but derives about 48% of its revenue from countries outside the USA.
MICROSOFT has broadened its product portfolio and strengthened its competitive advantage through acquisitions. It acquired LinkedIn, a professional networking platform, in 2016. Metaswitch Networks (Metaswitch) and Affirmed Networks (Affirmed) were acquired in 2020. Metaswitch is a cloud-based network software company that services companies such as communications service providers. Affirmed provides cloud-based 5-G ready solutions such as Virtual Evolved Packet Core and Affirmed UnityCloud to communications service providers. These acquisitions have enabled it to take advantage of fifth-generation (5-G) technology in addition to expanding its product offerings.
The Chief Executive Officer (CEO) of the company is Satya Nadella. Nadella has been with MICROSOFT for about 3 decades. He had held various positions in the company before he was appointed CEO in 2014. John Thompson was named the chairman, board of directors of MICROSOFT, in 2014. Thompson has vast experience of over 40 years in the technology industry.
Microsoft is a technology company that provides tools and platforms that enhance productivity. It is one of the few large players that have substantial resources to provide cloud computing services. Cloud computing has presented fresh opportunities to the company; it affords users easy access to information and applications from a large number of devices without direct investment in Information Technology (IT) infrastructure. Revenue from commercial cloud in 2020 broke all previous records; it made commercial cloud sales of $51.7 billion in that year.
Despite the fact that cloud computing is growing in prominence, we expect Windows and Office products to continue to produce earnings. Windows produced $22.3 billion in sales in 2020 compared to $20.4 billion in the prior year. Besides, LinkedIn that was acquired in 2016 has grown at a compound rate of 52.6% over the past three years. In 2020, MICROSOFT posted $11.6 billion in revenue from its gaming products which include Xbox hardware.
The company’s huge investment in Research and Development (R&D) and capital has not prevented it from paying dividends to shareholders regularly. Shareholders were paid $15.5 billion in 2020 (2019: $14.1 billion) in spite of R&D expenditure of $19.3 billion (2019: $16.9 billion) and capital expenditure of $18 billion (2019: $16.3 billion). Operating cash flow of $60.7 billion was also produced by MICROSOFT (2019: $52.2 billion). Free cash flow of $42.7 billion translated into $5.61 per share, 19.9% better than the preceding year’s figure.
The increasing acceptance of digital technology by both private and public entities is expected to bolster the earnings of technology companies, including MICROSOFT. The company is also positioning itself to benefit from the move to 5-G by acquiring Affirmed and Metaswitch. The company has agreed to acquire Nuance Communications Inc. (Nuance), its strategic partner since 2019. The acquisition of Nuance would strengthen the company’s capability to provide cloud services to healthcare and other industries.
Earnings Per Share averaged 3 times while Book Value Per Share was close to 9.4 times in eleven years. We have valued the stock of MICROSOFT and arrived at an estimate ranging from $149 to $163.8 per share.
MICROSOFT posted 13.7% year-on-year revenue growth to $143 billion for the 2020 financial year as a result of the company’s well-performing products. Revenue growth was propelled by commercial cloud which declared revenue of $51.7 billion, up from $38.1 billion announced for the 2019 financial year. Cloud computing’s share of total revenue is increasing; commercial cloud revenue produced 36.2% of total revenue in 2020 (2019: 30.3%; 2018: 24.1%). Over 60% of revenue comes from three major business segments, namely server products & cloud services, office products & cloud services, and windows. The server products & cloud services segment has recorded double-digit revenue growth for four straight years. Revenue from office products & cloud services grew by 11.2% to $35.3 billion from $31.8 billion of the prior year, 2019. $1.9 billion was added to sales from the windows division.
Operating income jumped 23.3% to $53 billion; it gained 22.5% or $7.9 billion a year ago. Though total costs increased by 8.7% year-on-year, it formed 63% of revenue compared to 65.9% in the previous year. Consequently, the operating income to revenue ratio rose by 2.9 percentage points. Net income for the year was $44.3 billion or $5.82 per share. Total comprehensive income went up from $41.2 billion to $47.8 billion on account of the net change in investments of $4 billion. Pre-tax income margin of 37.1% exceeded the eleven-year average of 32.8%.Net income margin was more or less flat at 31%. Return on Average Equity (RoAE) was 43.3% compared to 44.5% of the previous period while Return on Average Assets (RoAA) improved marginally to 16.3%.
Total assets and shareholders’ equity are getting bigger; over the past three years, total assets expanded by 6.4% to $301.3 billion while shareholders’ fund of $118.3 billion represented a 3-year compound annual growth rate of 10.5%. MICROSOFT does not have a working capital management problem; both current and acid test ratios hover around 2.6 times. Total debt was reduced by $8.9 billion and it stood at 21% of total assets and 53.5% of shareholders’ fund. The reduction of the debt in its balance sheet in the past four years has contributed to its falling leverage ratios. Besides, MICROSOFT generates a lot of income and cash flow from its operations; both operating income and operating cash flow covered interest obligations many times. Consequently, we have no reason to believe that MICROSOFT is insolvent.
MICROSOFT faces competition from companies providing cloud-based solutions, devices, software providers and online advertising. It derives about half of its revenue from countries outside the USA; so it is exposed to exchange rate fluctuations with an associated effect on earnings.
In addition, regulatory risk may pose a problem for the company; changes in laws or regulations, such as Anti-Monopoly Law, could restrict its growth as it operates in multiple jurisdictions.