Why I like Microsoft
Federico is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
In this article, I will explain why I like Microsoft (NASDAQ: MSFT) and describe its main growth drivers and the reasons why I think this company is a solid investment.
I think that the whole PC segment is not dead and the growth should continue driven by emerging market economies. Gartner estimates that PC shipments will grow 4.4% in 2012, an improvement over the 1.9% growth in 2011. IDC expectations are not too different. The research firm expects 5% growth in 2012, following a 1.8% increase in 2011. Both research firms continue to believe that Microsoft Windows 8 as well as ultrabooks will be the main drivers of growth for the PC sector this year. It is worth noting that despite these pressures, Microsoft dominant position in the traditional PC market and the enterprise refresh to Windows 7 continues to generate solid revenues and cash flows for the company. I found very interesting to mention a presentation from Intel that shows that PC growth is mainly driven by emerging markets economies.
Microsoft’s launch of Windows 8 platform, which supports ARM architecture, is expected to take a leap in the mobile computing market (an area where it continues to lag the iOS and Android significantly). The new OS is expected to launch in October, so there should be an uptick in mobile revenue once consumers adjust to the new interface. I think Windows 8 adoption rates will accelerate very late in 2012, possibly not before 2013. However, the company is taking steps to see that its offering is comparable with other mobile operating systems, such as iOS and Android. The recent agreement with Barnes & Noble indicates that the company is probably looking for a hardware platform partnership that could give it an initial toehold in the fast-growing tablet market. Although neither company said that future Nooks would be powered by Microsoft s OS (it currently runs on Android), it seems very likely.
Application developers need software platforms to develop and execute cloud applications, and Microsoft's Azure is poised to emerge as one of the largest platforms for cloud computing. Microsoft has the opportunity to migrate its existing army of .NET developers to the Azure platform, and the company has wisely focused on making this transition easy for customers. I think that Microsoft is taking the necessary steps to be a true leader in the whole cloud computing segment. Further, similar to their on-premise counterparts, I expect cloud platforms to be very sticky as a result of high switching costs, enabling vendors to reap significant economic profits. Competitive dynamics should favor early entrants like Microsoft, and I do not expect the playing field to get very crowded; the combination of first-mover advantages stemming from the stickiness of platforms, breadth and depth of technological expertise required to develop a robust offering, and large up-front capital investments pose formidable barriers to entry. As a result, I expect Microsoft to build an economic moat around Azure and generate high returns on invested capital from this business.
The Windows Server 2012 might not get the publicity that a consumer product such as Windows 8 would, but I think that it is central to Microsoft's strategy as the tech industry shifts toward cloud dominance. I think that Microsoft has positioned itself well for the cloud and virtualization revolution. Not only Microsoft has a suite of cloud-based consumer apps but also it has innovated on the back-end as well. Windows Server 2012 is built specifically for the cloud, seeking to provide a fast experience for applications and a robust platform for APIs. Microsoft's API platform with focus on cloud can be a big selling point for enterprises. The API platform will enable enterprises to create custom applications which can provide efficiency gains when run on the cloud. Additionally, reliable cloud servers can cut IT costs as maintaining a large, centrally located data center will be cheaper than maintaining local hard drives. If Microsoft can differentiate its offering from other competitors, I think that it could gain market share with its servers. If this materializes, it could provide upside to Microsoft's value.
Management has been executing very well. This has helped Microsoft build a net cash and short term investments balance of $63.0 billion ($7.52 per share). Microsoft also generates approximately $7-8 billion a quarter from operations and cash flow has been increasing in the last few quarters. The significant amount of cash provides the flexibility required to pursue any growth strategy, whether by way of acquisitions or otherwise.
I think that Microsoft is a solid investing considering that the company boasts an AAA balance sheet, pays almost 3% dividend yield, and is expected to increase revenues at a 6% to 8% average rate over the next two fiscal years. Despite a consistent run-up in its stock price over the last year, the stock is still selling near the bottom of its five-year valuation based on P/E, P/S, P/B, and P/CF. Also, the company has over $50 billion in net cash on the books, and the stock sells for less than eight times forward earnings after subtracting cash. I think that valuation does not reflect Microsoft core fundamental strengths.
In addition, Microsoft trades at lower multiples than competitors Oracle (NYSE: ORCL) and SAP (NYSE: SAP). Microsoft trades at a forward P/E of just 9.2x in comparison to Oracle´s 11.6x and SAP´s 16x. While projected growth is lower for Microsoft at 8.9% compared to 14% for Oracle and 12.8% for SAP, I think that the Microsoft current stock price represents an opportunity considering that the company is trading at the lower range of its 5 year P/E and P/CF multiples.
The company recently raised its dividend for seventh time since it originally paid a dividend in 2004. Microsoft said it will raise its payout 15%, and the stock now yields 2.9% based on the new dividend rate. I also like the fact that the new mobile OS continues to gain momentum, with HTC unveiling two new phones based on Windows 8. HTC was once the largest android smartphone maker, so this shows major progress in getting the company's software placed with the major manufacturers.
I feel that Microsoft deserves a higher valuation in the stock market. Steven Ballmer will need to convince Wall Street that Microsoft keeps growing and will be a leader in the new technology cloud computing environment.
federicoflom has no positions in the stocks mentioned above. The Motley Fool owns shares of Intel and Microsoft. Motley Fool newsletter services recommend Intel. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.