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Morningstar | Microsoft Continues to Evolve Into a Cloud Leader

Since taking over as CEO in 2014, Satya Nadella has reinvented Microsoft into a cloud leader that has become one of only two providers that can deliver a wide variety of platform-as-a-service/infrastructure-as-a-service solutions at scale. Microsoft has accelerated the transition from a traditional perpetual license model to a subscription model and embraced the open-source movement. Also, Microsoft exited the low-growth, low-margin mobile handset business and is driving gaming to be more cloud-based. These factors have turned Microsoft into a more focused company that offers impressive revenue growth with high and expanding margins.We believe Azure is the centerpiece of the new Microsoft. Even though we estimate it is already an approximately $7 billion business, it grew at a 92% rate in fiscal 2018. Azure has several distinct advantages, including offering a painless way to experiment on moving workloads to the cloud. Since customers remain in the same Microsoft environment, applications and data are easily moved from on-premises to the cloud. Microsoft can also leverage its massive installed base of Microsoft solutions as a touch point for an Azure move. Azure also continues to launch new services in the secular trends of artificial intelligence, business intelligence, and “Internet of Things.” Microsoft is also shifting its on-premises products to become cloud-based SaaS solutions, including LinkedIn, Office 365, and Dynamics 365. Like any transition, the initial move is painful, as both revenue and margins drop. However, Microsoft is now on the back end of that, where revenue has accelerated and is more predictable and margins are increasing. Office 365 retains its virtual monopoly in office productivity software, which we do not expect to change anytime soon. We believe that customers will continue to drive the transition from on-premises to cloud solutions, and revenue growth will remain robust, with margins continuing to improve for the next several years.