EUR 850.00 For Business Accounts Only

Morningstar | Microsoft Continues to Evolve Into a Cloud Leader; Shares Undervalued vs. Our $125 FVE

We believe Microsoft is a blue-chip technology stock that offers approximately 15% EPS growth in each of the next several years, powered by impressive 11%-12% top-line growth. We maintain our wide moat and stable moat trend ratings for Microsoft, and although we are lowering our fair value estimate to $125 per share from $130, we still view the shares as modestly undervalued. Our fair value estimate implies a price/earnings of 25 times on fiscal 2020 EPS.

Since taking over as CEO in 2014, Satya Nadella has reinvented Microsoft into a cloud leader. Most obviously, Microsoft has become one of two public cloud providers that can deliver a wide variety of platform-as-a-service and infrastructure-as-a-service solutions at scale. Additionally, Microsoft has accelerated the transition from a traditional perpetual license model to a subscription model. Lastly, Microsoft exited the low-growth, low-margin mobile handset business and is increasingly cloud-driven even in gaming. These factors have combined to drive a more focused company that offers impressive double-digit revenue growth with high and expanding margins.

We believe that Azure is the centerpiece of the new Microsoft. Even though we estimate it is already an approximately $7 billion business, it grew at a staggering 92% rate in fiscal 2018. Azure has several distinct advantages, including that it offers customers a painless way to experiment and move select workloads to the cloud. Since existing 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 all Microsoft solutions as a touch point for an Azure move. In addition, Azure is an excellent launching point for secular trends in artificial intelligence, business intelligence, and Internet of Things as it continues to launch new services centered on these broad themes.

Microsoft is shifting its traditional on-premises products to become cloud-based software-as-a-service solutions. Critical applications here include 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, so revenue has accelerated and is more predictable, and margins are increasing.

Office 365 retains its virtual monopoly position in office productivity software, which we do not expect to change in the foreseeable future. We believe that adding LinkedIn Recruiter to the Dynamics suite has increased the value of Microsoft’s evolving enterprise resource planning offerings. Overall, 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.