A Review Of Our Microsoft $42 Price Estimate

MSFT: Microsoft logo

Microsoft Corporation (NASDAQ:MSFT), the maker of  Microsoft Office productivity suite and Windows operating system, has been languishing below $30 for months. The company has a market capitalization of around $235 billion and generated revenues of approximately $73 billion in 2012. Microsoft is the leader in productivity software, operating system and server software markets, and these three divisions combined contribute over 75% of our $42 price estimate.

Microsoft’s current market price is at a near 50% discount to our estimate primarily because of a decline in sales of PCs and desktops, a chief driver for Microsoft’s software license sales. Moreover, increased mobile device penetration and changing technology habits have resulted in downbeat market estimates for revenue growth and lower margins for the company. To address these developments, Microsoft has launched new products such as Windows 8 OS, which is mobile device friendly and touch screen compatible. It has also launched Office 365 and Surface tablet to address the growing cloud and mobile device segments.

See our complete analysis of Microsoft here

New launches in Office to stem market share decline

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Microsoft’s biggest revenue driver is its Office productivity suite. This segment generated approximately $24 billion in revenue in 2012, and we expect this to grow to $27 billion by 2016. At 60%, this division has the highest margins for Microsoft, primarily due to a dominant 93% market share in the productivity suite market.

We expect Microsoft to maintain its dominant position on new launches such as Office 2013 and Office 365. Free productivity suites such as Google docs and Open office are alternatives to Microsoft Office but lack some premium features available to Office users.

Office 365, a cloud productivity suite launched to compete with Google docs, offers most of the Office features in Software As a Service (Saas) format. This product helps improve the user experience with mobile, social and cloud features – a technological shift that is transforming the way software is perceived by the users. Moreover, we think that Microsoft Office has a sticky user base that is reluctant to shift to a new platform and is critical for many professional and personal users. This makes it difficult for new entrants to make a meaningful dent into Office’s market share. With new launches and a loyal user base, Microsoft Office will be able to stem the decline in market share to around 90% by the end of our forecast period.

The server business to cater to increasing business requirements

The server business is Microsoft’s second largest business, making up around 22% of its total value. The is the lowest margin division with margins of around 38% on revenues of $19 billion. Microsoft generates around $1,400 per unit of server software sold and has around 75% market share, according to our estimates.

In spite of its low margins, the server business is key for the company’s long-term prospects. Many Microsoft customers depend on SQL servers for mission critical and business intelligence needs. Big data analytics and data storage is also gaining popularity.

SQL servers help clients in querying databases and analyzing such data. We expect SQL’s market share to increase in the future that will bolster the server division. Moreover, the Microsoft exchange server provides seamless compatibility with Windows based PCs and other Microsoft products such as the Windows Phone and the Surface tablet. This presents an opportunity to cross sell other Microsoft products such as Windows PC licenses and mobile devices. We think that Microsoft will maintain its market share in the server software division on changing business needs and seamless integration of its products across platforms.

Discounts on OEM OS prices to bolster sales

Windows Operating System is Microsoft’s third largest division and makes up around 14% of its stock value. In 2012, the company generated approximately $18 billion from this division, selling each Windows license to OEMs for approximately $48.

The sales of touch screen compatible Windows 8 OS, which was launched 6 months ago, has not met expectations. Microsoft sold close to 60 million licenses in the last quarter of 2012, which amounts to 68% market share for 87 million new PC and net book sales. The battle for market share in the OS segement is heating up, particularly in the mobile OS space that has Google’s Android OS and Apple’s iOS. Microsoft is offering discounts on Windows 8 prices to OEMs to bolster sales and maintain its market share. [1] This should help stem the decline in OS market share as the company will be able to limit client migration. Currently, Microsoft has approximately 75% market share in the operating system space, and we expect that to stabilize at 70% by the end of our forecast period.

Other division expected to add to profitability

We expect Windows 8 to aid the adoption of Microsoft’s Bing search engine. We estimate that the service has around 4% global search market share, but we think that this will expand over our forecast period with Bing as the default search engine on the OS. This improvement will contribute to an increase in Bing’s market share, which we think will reach around 6% by the end of our forecast period.

Skype continues to gain traction and has a registered user base of over 700 million subscribers. Skype complements the existing Microsoft product portfolio.

Currently, Microsoft offers a host of products across personal and enterprise domain. In the personal domain, Microsoft has MS Home, Windows Messenger and Hotmail. For enterprise solutions, it offers LYNC and Exchange. With Skype, Microsoft has a unique option of providing collaboration software that would encompass most of its products. We believe that Skype will turn profitable for Microsoft by the end of our forecast period.

We currently have $42 price estimate for Microsoft, which is approximately 50% above the current market price.

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  1.  Microsoft cuts Windows 8 OEM prices to spur demand, news.cnet.com []