Analys – Microsoft

Requested after Daniel Kakai signed up to UngaAktiespare, when I promissed to do a simple analysis on one company. He choosed Microsoft.

Microsoft don`t need a introduction, but lets see how Microsoft themselves divide in their business.

Productivity and Business Processes

Our Productivity and Business Processes segment consists of products and services in our portfolio of productivity, communication, and information services, spanning a variety of devices and platforms. This segment primarily comprises:

• Office Commercial, including Office 365 subscriptions, the Office 365 portion of Microsoft 365 Commercial subscriptions, and Office licensed on-premises, comprising Office, Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, and Skype for Business, and related Client Access Licenses (“CALs”).

• Office Consumer, including Microsoft 365 Consumer subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive.

• LinkedIn, including Talent Solutions, Learning Solutions, Marketing Solutions, Sales Solutions, and Premium Subscriptions.

• Dynamics business solutions, including Dynamics 365, a set of cloud-based applications across ERP and CRM, Dynamics ERP on-premises, and Dynamics CRM on-premises.

Intelligent Cloud

Our Intelligent Cloud segment consists of our public, private, and hybrid server products and cloud services that can power modern business and developers. This segment primarily comprises:

• Server products and cloud services, including Azure; SQL Server, Windows Server, Visual Studio, System Center, and related CALs; and GitHub.

• Enterprise Services, including Premier Support Services and Microsoft Consulting Services.

More Personal Computing

Our More Personal Computing segment consists of products and services that put customers at the center of the experience with our technology. This segment primarily comprises:

• Windows, including Windows OEM licensing and other non-volume licensing of the Windows operating system; Windows Commercial, comprising volume licensing of the Windows operating system, Windows cloud services, and other Windows commercial offerings; patent licensing; Windows Internet of Things; and MSN advertising.

• Devices, including Surface and PC accessories.

• Gaming, including Xbox hardware and Xbox content and services, comprising Xbox Live (transactions, Xbox Game Pass and other subscriptions, cloud services, and advertising), video games, and third-party video game royalties.

• Search.

To boil it down to make it easier to talk about the different branches they have and everything in the separate branch is not interestering and driving the biggest value forward.

In PB&P it is about the Microsoft suit and ERP systems, which is really important as I dont think a company today would function internally or externally without word, excel, and powerpoint.

IC is all about Azure.

MPC is hardware in form of PCs and Xbox, and will for the rest of this analysis focus on Gaming as a Service as this will drive growth and most likely improve margins.

Investment case

Microsoft is a one of the companies that are delivering the digital infrastructure in the world with their products, main focus are B2B with B2C complementing and creating lock in effects with more people getting know how of their products.

Productivity and Business process will be growing at the steady state of growth with high margins.

Intelligent Cloud will be the growth driver forward with high growth around 25% and continous high margins of 37%.

More Personal Computing have had steady growth with expanding margins, I estimate this will continue and the biggest driver will be the gaming segment. With more digital distribution in gaming this will increase the margins and the acquisition of Zenimax it is showing that Microsoft are serious about investing in the gaming segment. I would be last console and we will see a shift towards streaming. I would also not be surprised that they are breaking out gaming as a separate segment.

The acquisition of Nuance is intresting as it increases the capabilities in the intelligent cloud for the medical sector.

Anti-thesis points

-Getting too big to be able to innovate and moving the market itself

-Getting too dominated in the market and anti-thrust becomes a issue

-Valuation temporary high because of low interest rates.

-Gaming segment dont take off and inable to convert to a streaming model.

-Cloud segment stagnate and looses market share.

Segments

Lets look how the segments is looking financially.

No surprises that MPC has low growth numbers and that margins has increased since 2016 as purchases has gone from offline to online. Also more household getting high-speed internet making it more feasible buying XBOX gold.

PB&P has shown stable growth numbers between 13-20% with good operating margins well above 35%.

IC is the future growth story and will also be the way Microsoft keep their position as the number one supplier of business support systems.

Lets look att the different markets of Microsoft segments.

Productivity and Business Processes

We are seeing growth in the P&BS segment’s products with Dynamics and cloud services, and Microsoft 365. Dynamics products still increase in growth while Microsoft 365 has stayed on a

ERP system market has be stable but essantially without any growth from 2019 to 2024 according to Statista.

From 2019 to 2024 it is estimated to have a growth of 3,2 % in total from 2019 to 2024.

Looking at the projections of yearly growth Enterprise software has the highest growth compared to the other software sections companies invest in.

One particular datapoint that surprised me is that google apps is the most used productivity software worldwide, but a point can be to look at the price point. Were Google are cheapier in their suits of products. My take is also that a lot use Google apps because they are for free and the google suit of applications is suitable for technology companies, but not for consultant-ish companies. As powerpoint seems premium over google slides, which is illustrated by 5% answering Microsoft Powerpoint stand alone.

Office software is expected to grow 5.6 % from 2020 to 2025 which is around the expected level, meanwhile I believe Microsoft has a strong value proposition and are more able to increase the price every year with out any considerable churn.

Also need to consider P&BS are earning money on more areas than on the Office 365.

Intelligent Cloud

IC are growing since Q1 2019 over 20% per quarter year over year and with gross margins above 50% and it has grown to just under 70%. Showing that the margins can continue as the revenue increases and we see more scalability in the cloud business.

Since 2017 to 2019 has the Public cloud software as a service market share for Microsoft decreased, with the other part increased from ~45% to 70%.

Public cloud was still in the beginning and it is natural to have a fragmented market in the expension phase of the market. When we come to a saturation phase in the market it is expected to be consolidated, where Microsoft is a natural consolidator with their size and complementing suite of products.

The public cloud infrastructure as a service (IaaS) vendor share 2015 to 2019 is intresting to look at with it cosolidating around the 7 big vendors (displayed in the picture). Amazon Web Services (AWS) has been the clear leader with Microsoft as the main challenger as they increase their market share while Amazon has lost market share.

Can be due to Amazon had a first mover advantage and Microsoft has catched up and Amazon’s other services are seen as competition with the companies main business. See answers in the JPM CIO survey about the answers regaring Amazon.

The Public Cloud services worldwide end-user spending are projected to grow to $332 billions 2021 and $397 billions in 2022.

That are giving a growth between 2020 to 2021 of 23% and 2021 to 2022 19,5%. In a huge market that are counted in the hundreds of billions of dollars is this enourmous growth numbers. Microsoft have a pole position to capture the majority of the expected growth.

More Personal Computing

As mentioned I am focusing here on the Xbox part of the MPC segment and expecting the OEM and hardware to be stagnated. Xbox content and services have shown good growth in the last 4 quarters, which is not a surprised as the new Xbox console were expected to be released and the pandemic also increases the digital entertainment consumption.

The most important part is that the installed base increases with in the gaming segment.

Ampere Analysis has estimated following numbers in the installed base of the next generation of the PlayStation and Xbox. Playstation has always been the clear winner in numbers of players and sold consoles.

I expect this to continue to be this way, I am more looking forward for a bigger consumption of the content digitally. Especially acquisitioning more IPs to further develop the catalog for increasing the value proposition of their gaming platform.

As for Netflix is it important to build a bigger audience to spread out the costs of content on.

We see the MAUs increasing steadily every quarter, unfortunely are the data one year old and therefore says very little aboout the state of the MAUs

Cloud gaming market is expected to grow in 2021 to $1.45 billion, which is a growth of 130%.

The cloud gaming market is new area of the gaming market, we have a number of streaming services out and all are produced by a cloud or server provider. For exemple Stadia by Google, Luna by Amazon, and GeForce by Nvidia as the most known players in the area at the moment.

Based on the CIO servey JPM made in 2020 can we see that Microsoft are the number one company that companies will increase their IT spending with. Below you can read the qoutes CIO said about the main IT suppliers, Microsoft is the only one with more than one page.

Tack till Alexander Eliasson för JPM CIO surveyn.

Financials

Valuation and estimates

Alphabet and Amazon are the two best peers as they are the biggest competition with Microsoft’s products.

I have valued Microsoft at 306 per share in a DCF, this is with a CAGR of 11,1% during a period of 20 years. With an average EBIT margins of 40,5% which is estimating that operating margin will increase in all three segments.

They are going to be able to that with very little need of capital, essentially are a lot of the capital returned to the shareholders by share buy backs and dividends.

The last three years on average was 79% of the free cash flow returned to share holders through dividends and share buy backs. Microsoft are a cash flow generating machine.

Sensitivity analysis

Sensitivity anaylysis to see how robust the valuation is if I change the WACC, and the EBIT margin and Growth rate in terminal value.

Investacus Saverajus


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