Disclaimer: please do not base your investment decisions on any other people’s opinions in the world except for yourself.
This has been a long weekend and I thought there is absolutely nothing else to do on Monday other than to seek a new investment opportunity. As I usually do, will try to be objective and concentrate on the figures. Microsoft is not (yet) in my portfolio of stocks.
I do sincerely apologise for the length of this post in advance - I am not particularly great at being concise. You could have a look at similar posts for Netflix and Facebook, they are much shorter in length.
You may have noticed the title saying Q4 whereas most of the US corporations have only reported Q2 earnings recently. Sometimes there are exceptions and this is the case - Microsoft ended its fiscal year last month and reported its financial results for 2018. Below we will have a look at how they are doing and why the share price did not go down after Facebook and Twitter (-20% and -30% shortly after their earnings releases respectively). Microsoft has three key segments which we will take a deeper look into.
Productivity and Business Processes
This segment includes MS Office, LinkedIn, Dynamics and other Business Management software.
Revenue for this segment increased by 18% in comparison to 2017, from $30.4bn to $35.8bn. Unfortunately, Microsoft does not disclose how much it earns from each of these products separately (only the growth, which is illustrated in the table below). Except for LinkedIn, which got the revenue of $5.1bn - 14% of the total within its segment.
The number of paid Office 365 subscribers increased by 16% over the year: from 27m to 31.4m people. The research company Gartner claims that Microsoft obtained $13.8bn via MS Office in 2016, while their closest competitor, Google, only got $1.3bn on Google Docs.
Operating profit increased by 8% from $11.9bn to $12.9bn. Interestingly, LinkedIn has an operating loss of $987m and there is no detailed information on the other products.
Revenue growth in the Productivity and Business Processes segment:
|Dynamics products and cloud services||11%|
|Office commercial products and cloud services||10%|
|Office consumer products and cloud services||8%|
This segment includes the Azure data processing service, Windows Server, and the Windows OS.
Revenue for this segment went 17% up this year, from $27.4bn to $32.2bn. Sooner or later, Azure will be Microsoft’s most significant product. Whilst the exact Azure revenue is not disclosed, we can make a very educated guess: for comparison, Amazon’s AWS raised $21.2bn last year, with an operating profit of $5.5bn. According to Canalys, analytical agency, Amazon has taken 31.8% of the market, and Microsoft got 13.9%. If this is correct, Azure’s revenue can be somewhere between $8bn to $10bn a year. More importantly, Azure’s revenue grows at least 80% each quarter in comparison to the same quarter a year ago - and this trend has already lasted for 12 (!) consecutive quarters.
Operating profit increased by 26%, from $9.1bn to $11.5bn.
Revenue growth in the Intelligent Cloud segment:
|Server products and cloud services||26%|
More Personal Computing
This segment includes search engine Bing, games, gaming software and hardware such as Xbox and Surface.
Revenue for the segment increased by 9% compared to 2017 from $38.7bn to $42.3bn. The most significant growth is due to Xbox. Who knows, perhaps Microsoft is so impressed by the success of the Nintendo Switch and will decide to create its own portable console too?
Operating profit increased by 28% from $8.2bm to $10.6bn.
Revenue growth in the More Personal Computing segment:
|Xbox software and services||36%|
|Search advertising excluding traffic acquisition costs||17%|
Overall Net Profit
The overall profit fell by 35% since 2017, from $25.5bn to $16.5bn. But that is not a cause for concerns, all thanks to the tax reform. Microsoft returned their cash equivalents from offshore companies back to the US and now the state took a tax chunk of $13.8 billion in the 2nd quarter of this year. This is not a systematic loss, so the market did not panic and sold off the shares. On the flip side, next year’s growth will most likely be abnormally high since the comparison will be to the year 2018.
In May, Microsoft agreed on the purchase of Github - a platform which I can hardly define properly… So I will just leave the explanation link. The deal is estimated to be finalised by the end of 2018. Github owners will receive $7.5bn in a form of Microsoft shares.
According to rumors, Github’s annual revenue is circa $300m - it is not much at all. Perhaps Microsoft will use it as a marketing platform or as part of some other product. The financial indicators of Github will most likely be displayed in the Intelligent Cloud segment.
Dividends and Shares Buyback
Microsoft paid $0.42 of dividends each quarter in 2018. The next payment will most likely increase again, as it has been the case with annual uplifts for the past 12 years.
Microsoft also has $30bn to buyback its own shares. $7.5bn will be paid for the deal with the Github and the rest of the money will most likely be used to buy shares from the market. This is an alternative (to dividends) way to pay the investors: fewer shares circulating in the market - higher dividends paid per share.
Microsoft’s and its close competitors’ Ratios
To evaluate a company, you need to compare its earnings figures to their competitors’. Microsoft has a lot of products, so let’s take slightly more competitors than usual:
- Outlook competes with Gmail; Bing with Google; Office 365 with Google Docs.
- Azure with AWS.
- Windows with Mac OS.
- Microsoft Dynamics with Oracle Cloud and IBM Cloud.
Ratios explained in detail (my personal gratitude to yourself if you are still reading up to this point)
- EV/EBITDA: The less, the better, close to or less than 10 is often a severe undervaluation. 10 rarely happens with Technology stocks as they are often valued by future potential than current performance.
- EV/CF: Same as EV/EBITDA but considers real cash flow instead of accounting profit. Once again, Technology are slightly diffirent to the other sectors and often have higher margins than other companies due to lower operational costs. Hence greater cash flows that usually exceed the profit from the Income Statement.
- Debt/EBITDA: At least how many years the company will need to repay the debts. Under 3 - usually fine. Over 5 - risky. Microsoft’s debt is more than reasonable hence the risk is fairly negligent.
- ROIC: Profitability. But excluding one-off costs and revenues (ever tried to “exclude from summary” one of your Monzo transactions? This is that). 15% and over is generally fine. Facebook’s is absolutely marvelous. More about ROIC here if interested.
Microsoft has a very wide range of products with significant revenues - Windows, Office, Azure, LinkedIn, Dynamics, Bing, Surface, Xbox and other software that did not make it to this list. It would be false to claim that they are all profitable - there are no figures disclosed for each of these products (except for LinkedIn - and it made a loss). However, Microsoft itself does not depend on any single product entirely, unlike its competitors:
- 62% of Apple’s revenue is iPhone
- 61% of Amazon’s revenue is Amazon Retail
- 86% of Alphabet’s revenue is advertising
- 98% of Facebook’s revenue is advertising
- IBM does not yet have breakthrough major projects that will help their revenue growth at all - not interesting for the US investors
- Oracle only recently separated their cloud solutions in a separate segment. They have a potential but no clarity yet
Evidently, with such a diverse range of products, Microsoft has its hands in most areas of the sector, hence should the recession get into any of those - Microsoft could always rely on other segments of its business model to sustain its normal operation and earnings growth.
As always, I could have missed some facts and figures, or they simply did not make it to the post due to the abundance of information available, which is why I am happy to hear what others think of Microsoft and its potential in the following years.