Microsoft Corporation

-1.15 (-0.25%)
7:59:58 PM EDT: $453.08 -0.47 (-0.10%)
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Why Microsoft is Dangerous, on the Attack and its Stock Could Rise


Microsoft has long been an inflexible and slow to adapt company -- the total opposite of it's biggest rival Apple (AAPL). The fact that the firm has totally missed everything with respect to mobile phones is in many ways one of the great corporate failures ever for such a high quality firm as that same technology made Apple the largest company in the world. But something is happening now; something unimaginable. MSFT is adapting. MSFT is becoming flexible. MSFT is competing. And now, MSFT may be winning.

The most interesting thing that MSFT is doing surrounds how it has opened up its platform to other operating systems. With an investment in Cyanogen, which creates its own flavor of Google's (GOOGL) open source Android, MSFT has boldly thrown an even greater monkey wrench into the Android chaos. Microsoft's adaptability and dare we say, flexibility, are proving to be stunning changes from the once stodgy and immovable firm of the past decade. In a wonderful article written by Tony Bradley and published on Forbes entitled Microsoft Has Hijacked Android In A Hostile Takeover, we get a deep dive into that flexibility as it surrounds Android.

In late May Microsoft announced that it had created partnerships with nearly two dozen Android OEMs to install, you guessed it, Microsoft Office, OneDrive and Skype onto their Android powered tablets. Microsoft is looking to explode the revenue the firm already generates from Android users and this feels a lot like what MSFT did to Apple in the days of the Mac, where more money went to MSFT than Apple (AAPL) for every Mac sold. While the death of office was once a forgone conclusion, now it's just foregone.

Microsoft is fulfilling CEO Satya Nadella’s goal of going platform-agnostic including offering the same apps on iOS.

And let us not forget business cloud computing which is on track for over $6 billion revenue this year. Even more evidence of flexibility, MSFT is dropping the most hated browser on planet Earth (Internet Explorer) and introducing Project Spartan with Windows 10. And while we're at it, Microsoft heard the jeers so loudly surrounding Windows 8, it just went ahead and skipped Windows 9 and went straight to Windows 10. That's circumstantial evidence of a legitimately different core value system within the firm.

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Another of the most interesting facts surrounding MSFT is how much the firm spends on research and development (R&D). In fact, it spends more than every company in North America across all sectors other than Intel (INTC). In the scatter plot below we chart R&D on the y-axis and equal space the x-axis.

Technicals   |   Support: 44.15   |   Resistance: 48.72    

Swing Golden Cross Alert: The short-term 10 day MA is now above the 50 day MA.

MSFT has a three bull (stock is range bound) technical rating because its trading above its 10- and 200-day moving averages, but below its 50- day moving average. We also note that the 10-day MA is below the 50-day MA ("swing death cross").

Here are the consensus estimates for next quarter. Note that last quarter's actual result is included at the far right.
Earnings Date EPS Revenue (Mean) Revenue (Median) Last Quarter (Actual)
2015-07-21 $0.56 $21.8 billion M $21.9 billion M $21.7 billion M Provided by ZACKS

Let's look at the core elements that drive the company's fundamental rating.

Fundamentals Rating Summary

Revenue (TTM US$ Millions) 94,782 83,347 76,012 RISING

Operating Margin (QTR) 1.454 1.52 1.69 FALLING

Net Income (TTM US$ Millions) 20,000 22,427 16,406

Levered Free Cash Flow (TTM US$ Millions) 23,333 17,878 22,774 RISING

Research and Development (US$ Millions) 2,984 2,743 2,640 RISING

Research and Development Expense/Revenue 0.137 0.134 0.129 RISING

Stock Returns and Chart

MSFT is up +0.2% over the last three months and up +9.5% over the last six months. The stock has returned -1.8% over the last year.

Before we dig into the fundamental trends that drive the rating, let's look at a two-year stock chart with regression channel and 10-day momentum (on the bottom).
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Now let's examine the visualizations of the critical financial measures.

Revenue (TTM US$ Millions) 94,78283,34776,012RISING

There is good news and bad news for MSFT in its fundamentals. Revenue is one of the "good," as it has risen 13.7% in the last year and nearly 25% from two-years ago. In fact, MSFT now stands at an all-time high in revenue for any trailing-twelve-month period.

Last reporting period MSFT stated that commercial cloud revenue grew 106% (up 111% in constant currency) driven by Office 365, Azure and Dynamics CRM Online, and is now on an annualized revenue run rate of $6.3 billion. Add to that the potential from Android OEM partnerships and you've got a compelling reason to believe more revenue growth is coming.

What do all these numbers mean?
MSFT's fundamental rating benefited these results:
1. The one-year change was positive (but no extra points were given for a large percentage increase).
2. The two-year change was positive.

Let's look at Revenue (TTM US$ Millions) in the chart below.

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Net Income (TTM US$ Millions) 20,00022,42716,406
This is where the trouble lies for MSFT. Not only is net income (TTM) lower than it was a year ago, it has been down five consecutive quarters (which triggers a "trend"). We've plotted the trailing-twelve-month number in the blue bars and the quarterly number in the orange line. Note that the TTM number hasn't been this low since June of 2010. But that may all be changing as hardware sales start to hit the bottom line (even though they are small) and platform-agnostic starts to take charge.

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Levered Free Cash Flow (TTM US$ Millions) 23,33317,87822,774RISING

Interestingly, as net income is dropping rather abruptly, levered free cash flow (FCF) TTM is growing. In fact, year-over-year it's up a remarkable 30.5%. However, compared to two-years ago, the number has barely moved. Remember, the thesis here is that MSFT has been "stuck," and that it is now ready to become "unstuck."

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Research and Development (US$ Millions) 2,9842,7432,640RISING
We discussed R&D at the top and the massive spend that MSFT is on. If we measure R&D per dollar of revenue it's actually pretty steady, but I do note the overall number. The bullish thesis for MSFT is that this expense, right here, is going to turn into an asset which will drive revenue, net income and free cash flow. R&D is up 9% year-over-year and 13% over the last two-years.

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Microsoft has totally missed the boat (up until now) on one of the greatest tech opportunities ever in the smart phone.

The bullish thesis for Microsoft is compelling: There's a whisper that their devices may start selling; in fact, the company reported Phone hardware revenue of $1.397 billion last quarter, up from $0 in the year ago period, and that was nearly exactly the "revenue beat" in last quarter's earnings.

But the whisper is not the excitement here. It's the roar from MSFT that it is attacking the echo systems of Google (GOOG) (and maybe Apple (AAPL)) by finally adapting, changing and leading change rather than insisting its way will work. Don't forget about the greatness that once was MSFT, because it may be coming back in exactly the same way it first was created. Add to that a booming cloud computing business, and you have the makings of a bullish story.

The bearish thesis focuses on dropping net income and the reality that Microsoft has no real hardware play in the greatest hardware product ever since the PC. While agnostic-free platform sounds like a nice idea, who's to say MSFT can shift? If it can't, then it truly is a relic of yester-years technology.

The bulish thesis is more compelling and more accurate in the long-term in my opinion.

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