Revising Our Price Estimate For Microsoft To $87

by Trefis Team
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Microsoft (NASDAQ: MSFT) reported excellent growth in revenues in 2017. Based on the company’s performance in 2017 and its outlook for the next few years, we have revised our price estimate for Microsoft’s stock from $66 to $87, which is about in line with the current market price.

The 30% upward revision in our price estimate was driven by growth in revenues from the Productivity and Intelligent Cloud verticals. Furthermore, based on its fiscal 2017 performance, we have revised our margin forecast upwards across verticals as the margin profile for the company improves due to a shift to cloud service. Cumulatively, this has resulted in a $22 per share increase in our valuation for Microsoft. Below we explain the changes in more detail.

See our complete analysis of Microsoft here

Productivity And Business Processes Revenues Set To Grow

Microsoft’s Productivity and Business Processes revenues, which include the Office suite, Dynamic CRM and ERP and LinkedIn, has grown from $27 billion in 2014 to $30.5 billion in FY2017 primarily due to the growth in Office 365 cloud services and Dynamics cloud software. The company continues to roll out integrated productivity solutions, which bundles Windows 10, Office 365, Enterprise security and mobility for organizations, in order to boost its productivity revenues. It is also offering a cross-sales platform that integrates Dynamic CRM and LinkedIn capabilities to its clients to improve its presence in the ERP and CRM domain.

Microsoft’s revenues from Office 365 – from both the consumer and commercial segments – and Dynamics 365 have improved significantly in the previous years. Considering the adoption of Office among enterprise and consumer clients alike, we expect the revenue run rate from Office 365 to increase further. We also believe that the adoption of Dynamics 365 will positively impact Business Processes revenues, as the platform can leverage Microsoft’s ecosystem to sell other products by bundling more value-added services. As a result, we currently project segment revenue to increase to $45 billion by the end of our forecast period.

Furthermore, we expect margins to improve as the company is increasingly selling more subscriptions for its cloud services compared to perpetual licenses. These hosted solutions generally have higher profit margins than the traditional suite, and we project the company’s Productivity and Business Processes operating margin to improve to around 42.5% by the end of our forecast period.

Azure Platform Powers Intelligent Cloud Revenues

The Intelligent Cloud segment (Azure, Server products, and enterprise services) saw its revenues grow by a CAGR of 8.1% over 2014-2017 to $27 billion. While Server products and Cloud services revenue grew in mid-single digits, driven by growth in Microsoft SQL Server, adoption of the cloud-based Azure platform resulted in triple-digit growth in revenues. As a result of these products, the company’s Cloud revenue run rate exceeded $20 billion in 2017. Furthermore, the Azure platform, which offers IaaS and PaaS services, continues to gain traction and its market share has gone up to 10% recently. The company continues to add capabilities such as AI to its Azure hybrid cloud offering. As a result, Azure is fast emerging as an attractive platform for Microsoft’s clients for Infrastructure as a Service (IaaS) and Platform as a Service (PaaS). Based on these trends, we expect this division to become an important driver for Microsoft’s value in the coming years. We forecast Intelligent Cloud revenues to grow to over $37 billion by the end of our forecast period.

We also project operating profit margins to improve to 35% by 2024 as the cloud service ARR grows in the coming years.

Windows OS, Hardware Launches Bolster Personal Computing Division

Over the course of the last two years, Microsoft has ramped down the production of smartphones as the division was not able to make much headway in the smartphone market. As a result, revenues from the phone business have declined by over 95%. However, Microsoft’s Personal Computing division did well in 2017, largely due to the adoption of Windows OS, the launch of its Surface line of devices and growth in Bing’s online search ad revenues. As a result, the revenues declined marginally by 4% in fiscal 2017 to $38.7 billion.

While we expect that Windows OS sales for both Windows OEM non-Pro and Pro will continue to outperform PC sales in the coming years, the secular decline in PCs will impact revenues. As a result, we project revenues from the PC division to grow marginally to around $38.4 billion by 2024, aided by growth in revenues from Xbox, Surface line of devices and Bing search.

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