Microsoft Q4 Earnings Preview: Cloud Revenues To Grow, OS Revenues To Remain Tepid In Q4

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Microsoft (NASDAQ:MSFT) is set to announce its Q4 FY 2015 earnings on Tuesday, July 21st.  (Fiscal years end with June.) Microsoft is undergoing change in its business as it focuses less on the aging  operating systems and applications business, which is dependent on the sale of personal computers, and more on the cloud business that comprises a developing ecosystem of cross-device applications and value added services. Over the course of last two quarters, Microsoft has re-stated its commitment to developing a comprehensive suite of software that extensively uses cloud technology, and is easily deployable on mobile devices. The aim is to line up Microsoft’s businesses with the changing landscape in technology, especially in enterprise software segment. Furthermore, it is focusing on high margin business, and reducing exposure to highly commoditized and competitive businesses such as online display ads and smartphones. During this earnings announcement, we will continue to monitor its growth in cloud services, and expect it to report growth across its verticals. In particular, we will continue to closely monitor its revenue growth from productivity (Office) and operating systems division as these are Microsoft’s cash cows.

See our complete analysis of Microsoft here

Revenue From Cloud Products In Focus

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Currently, Microsoft generates $93 billion revenues annually according to our estimate. Most of its revenue stems from the sale of packaged or licensed software, including mainstays such as the Windows OS, Microsoft Office and (to enterprise clients) SQL server. However, over the past few years, changes in the IT landscape, facilitated by improvement in hardware and advent of mobile devices, have encouraged Microsoft to extend its services into the cloud domain. One such factor is the declining demand of PCs and servers that lowers demand for its software. Other factors include price sensitivity of clients that want to cut down their costs and only pay for services that are rendered, based on the scale of operations. As a result, Microsoft has adopted cloud-first strategy to bolster its revenue in the coming years.

Its Office 365 offering continues to bolster revenues for the Windows Office division, which makes up ~40% of our estimated value. In the previous quarter, the company reported 106% growth in its cloud revenues, which includes both Office 365 and Azure sales. It enterprise mobility solutions address the growing need of enterprise apps that makes employees productive when they are on the move. We believe that these steps will augur well for the company and help it in maintaining its market share in the future.

In Q3 2015, Microsoft reported that Office 365 had over 12.4 million subscribers and the 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 will be recurring and thus more 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 increases  in both subscribers and the revenue run rate for Office 365. We anticipate that Office 365 will attain a greater than $1.8 billion annual revenue run rate as its clients adopt the feature-rich, cloud-based Office software.

Microsoft’s Windows Server division is the second largest business unit, making up over 24% of its total value. The strong adoption of cloud-based Azure platform continues to drive growth at the server division, as the company continues to form partnerships with companies such as Salesforce.com to boost its portfolio of services. During the Q3FY15 results, Microsoft said that its cloud computing business (which includes revenues from Azure, Office 365 and Dynamic CRM online) generated over $6.3 billion in annualized recurring revenue. We believe that the cloud based Azure platform and Dynamic CRM 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 its recently launched Business Intelligence tools. We expect the server division revenues to get a boost due to the bundling of these services. Therefore, we believe the company will report good growth in revenues in this quarter as well.

Windows OS Sales To Slide In The Quarter

The 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. Recent data from IDC indicates that PC shipments declined by 11.8% in Q2 2015 as clients deferred buying new PCs in anticipation of Windows 10, which will be launched at the end of this month. [1] While we expect new PC shipments will help Microsoft post some growth in license sales during the quarter, disappointing PC sales and client deferrals in anticipation of the Windows 10 launch might dent revenue growth in Q4. Overall, we expect revenues for Windows OS division to slide for the quarter.

We have $44.46 price estimate for Microsoft, which is in line with the current market price.

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Notes:
  1. PC Market Continues to Decline Ahead of Windows 10 Release, According to IDC, July 09 2015 []