Microsoft Corporation (NASDAQ:MSFT), one of the biggest software companies in the world, makes money primarily via sales of its Microsoft Office productivity suite and Windows operating system. The company has a market capitalization of above $200 billion and generated revenues of approximately $70 billion in 2011. It has a dominant position in almost all of the industries that it operates in. It has 95% market share in the productivity software market, 75% share in the operating system market and approximately 75% share in the server software market. Overall, we think that these three divisions are in a relatively good shape even though they are subject to increasing competition and that their dominance is key for Microsoft since its other products rely on the Windows and Office ecosystem.
Microsoft depends on Office’s dominance
While Microsoft’s Windows OS is the product that garners the most attention, Microsoft’s biggest revenue driver is Microsoft Office productivity suite. This segment generated approximately $23 billion in revenue in 2011, and we expect this to grow to $26 billion by 2016. The division has the highest margins for Microsoft at around 60%, which is primarily due to its dominant 95% market share in the productivity suite market.
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However, we expect that Microsoft Office’s market share will decline to around 90% by the end of our forecast period. We believe that free productivity suites like Google Docs and Open Office are providing an alternative to users who don’t need the full power of the Microsoft Office suite. We think that downsides to Microsoft’s forecast on the Office suite front are possible especially if a new entrant comes in and provides a better solution for enterprises. But we think that the likelihood of this is low since the Office suite is far ahead of the competition in terms of capabilities and has a sticky user base as users are reluctant to shift to new platforms.
What many consider as Microsoft’s flagship product, the Windows Operating System, is Microsoft’s second largest division making up around 25% of its value. In 2011, Microsoft generated approximately $17 billion from this division, selling each Windows license to OEMs for approximately $54. At present, Microsoft has approximately 75% market share in the operating system space and we expect this to decline to around 70% by the end of our forecast period because of competition from Apple’s (NASDAQ:AAPL) Mac OSX and free open-source operating systems such as Linux.
We think that Windows will be able to maintain its market share at around 70% over our forecast period because of its new OS release, Windows 8. We think that the operating system will be a game changer for the PC industry primarily due to its touch screen compatibility, something that isn’t yet matched by Apple’s Macbook.
Windows Servers Key in for Cross-Selling Products
Microsoft’s server business is its third largest business, making up around 17% of its total value. The division is Microsoft’s lowest margin division, with margins of around 40% on revenues of $18 billion. Microsoft generates around $1,400 per unit of server software sold and has around 75% market share out of the 110 million units per year sold globally.
While Microsoft’s server division is its lowest margin business, we think it is the key for the company’s long-term prospects. If an organization uses an Exchange server, it has a high likelihood of using Windows based PCs and will prefer that its employees have other Microsoft products such as the Windows Phone and the Surface tablet to ensure seamless compatibility. Therefore we think that if Windows servers maintain their market share in the server market, it will drive PC and phone sales and help keep Microsoft’s overall business in good health.
Windows 8 to benefit Bing
In our opinion, one of the key benefits of the new Windows 8 release will be an increase in market share for Microsoft’s search engine, Bing. At present, the service has around 4% global search market share, but we think that this will increase over our forecast period because Bing is the default search engine on the OS. Overall, we think that Microsoft’s development team has done a good job with the Bing application, making the search engine simple to use. This improvement will contribute to an increase in Bing market share, which we think will reach around 6% by the end of our forecast period.
We currently have $42 price estimate for Microsoft, which is approximately 50% above the current market price.