Microsoft Earnings Preview: Focus on Hardware And Cloud Sales

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Microsoft (NASDAQ:MSFT) is set to announce its Q1 FY 2015  earnings on Thursday, October 23. (Fiscal years end with June.)   Microsoft is undergoing change in its business as it focuses less on the aging operating systems business, which is dependent on the sale of personal computers, and more on the cloud business that comprises a developing ecosystem of devices and value added services. The aim is to assure that Microsoft’s businesses accommodate the major changes underway in computing, including Big Data and the Cloud.   For this quarter, we continue to monitor its hardware and cloud service, and expect it to report growth in both these verticals. Additionally, we will continue to closely monitor its revenue growth from mobile devices and operating systems division.

See our complete analysis of Microsoft here

Focus On Hardware Sales

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Microsoft is increasingly pursuing its devices and services strategy to reduce its reliance on PCs and expand its footprint into the mobile hardware domain. At the end of June, it launched Surface Pro 3 to boost its ecosystem and cater to the high end of the tablet market. Furthermore, it recently announced launch of upgrades to its existing line of Nokia’s Lumia phones. [1] In this earnings announcement, we will closely monitor Microsoft’s unit sales and revenue numbers for its devices and consumer hardware segment. This would give us a fair indication of how these devices have fared and whether its devices are gaining traction among users.

Cloud Products To Drive Revenue Growth At Office Division

Microsoft is steadily making progress in the cloud domain. Its Office 365 offering continues to bolster revenues for Windows Office division, which makes up 40% of our estimated value. On the other hand, the strong adoption of cloud based Azure platform continues to drive growth at the server division, which makes up 24% of our estimated value for Microsoft. In the previous quarter, the company reported 147% growth in its cloud revenues, which includes both Office 365 and Azure sales. The company continues to support the adoption of its cloud services through a host of initiatives such as free Office 365 for iPad. We believe that these steps will augur well for the company and help it in maintaining its market share in the future.

In Q4 2014, Microsoft reported that Office 365 had over 5.6 million subscribers and that revenue from this cloud offering in the quarter more than doubled year over year. As subscription model for office sets in, revenues for this division are expected to become more recurring and predictable going forward. Currently, we estimate that the company has close to 93% share in productivity software market. In the upcoming earnings announcement, we expect Microsoft to report increase in subscribers and revenue run rate for Office 365 as its clients adopt the feature-rich, cloud-based Office software. We anticipate that Office 365 will clock in over $1.7 billion annual revenue run rate as its clients adopt the feature-rich, cloud-based Office software.

Focus On Cloud Services To Bolster Server Division

Microsoft’s Windows server division is the second largest business unit, making up over 24% of its total value. Its flagship Azure platform continues to gain traction even as the company continues to form partnerships with companies such as Salesforce to boost its portfolio of services. We believe that the Azure platform will be a key growth driver for Microsoft going forward as companies around the world are looking to lower costs by adopting cloud based services. Additionally, many Microsoft customers depend on SQL servers for mission critical and business intelligence needs, specifically in the big data analytics domain. The company can leverage the popularity of its SQL server and Azure platform to sell the recently launched Business Intelligence tool. We expect the server division revenues to fillip due to bundling of these services and the company to report good growth in revenues in this quarter as well.

PC Sales To Affect Windows OS Sales

Windows Operating System (OS) is Microsoft’s third largest division and makes up around 10% of its stock value by our estimates. Recently, this division has reported growth in revenues, primarily due to Microsoft’s termination of support for Windows XP, which is forcing laggards to upgrade from this popular OS. While the severity of PC shipment sales eased off in Q3 2014, we expect new PC shipments, together with the existing installed base of Windows PCs, should help Microsoft post growth in license sales during the quarter. In this earnings announcement, we will continue to pay close attention to the numbers of licenses of Windows sold in both desktop and mobile verticals. We also expect to get an update on Microsoft’s next OS, Windows 10, which it recently released for technical preview as an early beta.

Bing Revenues In Focus

The Online Services Division has negatively impacted Microsoft’s overall profitability as it continues to post operating losses. However, due to rise in Bing’s penetration, the division’s revenues have increased by 40% year-over-year in Q4. [2] Furthermore, its market share in the search market industry in the U.S. has increased by 1.4 percentage points in September 2013 to 19.4%. [3]. We expect this trend to positively impact revenues, and the company to report growth in revenues and profitability from Bing in this earnings announcement.

We have $44.26 price estimate for Microsoft, which is inline with its current market price.

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Notes:
  1. Read more about it here []
  2. 8-K10-K []
  3. comScore September 2013 and  September 2014 data []