Company Overview: Microsoft Corporation is a technology company. The Company develops, licenses, and supports a range of software products, services and devices. The Company's segments include Productivity and Business Processes, Intelligent Cloud and More Personal Computing. The Company's products include operating systems; cross-device productivity applications; server applications; business solution applications; desktop and server management tools; software development tools; video games, and training and certification of computer system integrators and developers. It also designs, manufactures, and sells devices, including personal computers (PCs), tablets, gaming and entertainment consoles, phones, other intelligent devices, and related accessories, that integrate with its cloud-based offerings. It offers an array of services, including cloud-based solutions that provide customers with software, services, platforms, and content, and it provides solution support and consulting services.


MSFT Details

Beaten the Market Estimates with strong performance in the fourth quarter 2018: Microsoft Corporation (NASDAQ: MSFT), that enables digital transformation for the era of an intelligent cloud and an intelligent edge, reported better than expected results for the fourth quarter 2018. MSFT in the fourth quarter of FY 18 has reported the adjusted earnings per share of $1.13, beating the analysts’ estimates for the adjusted earnings per share of $1.08. The company had reported the adjusted revenue growth of 17 percent to $30.09 billion in the fourth quarter of FY 18, beating the analysts’ estimates for revenue of $29.21 billion. The company’s commercial cloud business exceeded revenue over $23 billion for year 2018 while gross margin expanded to 57%. Gaming revenue, driven by the strong performance of Xbox Live, Game Pass subscriptions and Mixer, rose by 39 percent, that is more than doubling last quarter's 18 percent growth rate. The Gaming revenue has surpassed $10 billion mark in revenue this year for the first time. Overall, in the fourth quarter of 2018, there  has been 13% rise in revenue of Productivity and Business Processes to $9.7 billion. This includes 10% rise in Office commercial products and cloud services revenue on the back of Office 365 commercial revenue growth of 38%. Office consumer products and cloud services revenue grew by 8% and Office 365 consumer subscribers rose to 31.4 million in the fourth quarter 2018. The company’s Dynamics products and cloud services revenue grew  by 11% on the back of 61% rise in Dynamics 365 revenue. During the fourth quarter of 2018, the company delivered 23% growth in the revenue of Intelligent Cloud to $9.6 billion, including server products and cloud services revenue growth of 26% driven by Azure revenue growth of 89% and 8% rise in Enterprise Services revenue. Moreover, in the fourth quarter 2018, MSFT delivered 17% growth in the revenue of More Personal Computing to $10.8 billion. This includes, a rise of 7% in Windows OEM revenue, which has been up 7% in constant currency, with OEM Pro revenue surge of 14%. Revenue for Windows commercial products and cloud services rose by 23%, up 19% in constant currency, in the fourth quarter based on rise in volume of multi-year agreements with product mix carrying higher in-quarter revenue recognition. The surface revenue in fourth quarter of 2018 jumped up 25%, up 21% in constant currency, with performance of latest editions of Surface against a low prior year comparable and 17% increase in Search advertising revenue excluding traffic acquisition costs on the back of higher revenue per search and search volume. Additionally, during the fourth quarter of 2018, operating income rose 30 percent (24 percent in constant currency) and gross margin percentage was 68 percent, ahead of the company’s expectations, and up 1 point year over year due to improvement in the More Personal Computing segment, driven by Surface.


Q4 2018 Financial Performance (Source: Company Reports)

Investments giving great results: MSFT’s investments in Power BI, PowerApps and Flow as the new analytics and application platform have gained significant momentum with ISVs and enterprise customers. The company is strategically investing aggressively to build Azure as the world’s computer. Azure is the only hyper scale cloud which extends to the edge, across identity, data, app platform, security and management, and the differentiated architectural approach has led strong growth in the fourth quarter 2018. MSFT has added nearly 500 new Azure capabilities in the last year, and is focused on both existing workloads and new workloads such as IoT and AI at the Edge. Azure is growing rapidly, as the segment witnessed 89 percent rise in revenue in the fourth quarter 2018. However, this is modest deceleration from the 93 percent growth posted last quarter, which is still encouraging for the company in order to focus on the segment. Further, MSFT has introduced Azure Stack and Azure Sphere, which are first-of-their kind cloud-to-edge solutions that are already experiencing strong customer demand.

Strategic Partnerships: GE and Microsoft Corp. have expanded their partnership, and brought together operational technology and information technology to remove the hurdles that industrial companies face in the advancing digital transformation projects. Under the partnership, GE Digital has planned to standardize its Predix solutions on Microsoft Azure, and will integrate further the Predix portfolio with Azure’s native cloud capabilities, including Azure IoT, Azure Data and Analytics. The parties have planned to co-sell and go-to-market together, will offer end customers premier Industrial IoT (IIoT) solutions across verticals. Further, GE will use Microsoft Azure across its business for additional IT workloads and productivity tools, that include internal Predix-based deployments. Moreover, MSFT has made the partnership with Campbell Soup Co. to modernize Campbell’s information technology (IT) platform through the Azure cloud which will streamline workflows and drive efficiencies.

Ethereum-based blockchain product launched: MSFT has brought a new Blockchain as a Service (BaaS) product, which will allow businesses across industry verticals to deploy a flexible instance of Ethereum made specifically for enterprise environments. Ethereum Proof-of-Authority on Azure is planned to allow enterprises to build applications on an Ethereum blockchain that is not secured by a Proof-of-Work (PoW) consensus algorithm and consequently does not require mining. This feature is better suited for networks in which participants do not trust one another.

Strong Performance of LinkedIn: 2018 proved to be a strong year for LinkedIn, which has now more than 575 million members; and for the fourth quarter posted the revenue growth of 37%, which is the fifth consecutive quarter of revenue acceleration. The company witnessed strong levels of engagement and job postings in the fourth quarter, with sessions growth up 41% year-over-year. This strong engagement is on the back of the quality of the feed, video, messaging and acceleration of mobile usage as the mobile sessions were up more than 55% year-over-year. The company plans to continue to invest to make LinkedIn the essential platform to connect the world’s professionals and help them achieve more with experiences powered by LinkedIn and Microsoft graphs.


LinkedIn Financial Performance  (Source: Company Reports)

Outlook: As per the company, the cloud computing market alone is expected to grow from $285 billion last year to $411 billion by 2020. The segment is big enough to drive the company’s revenue growth for the next three to four years. Meanwhile, for the first quarter of 2019, MSFT expects FX to deliver revenue growth by approximately 1 point and decrease COGS and operating expenses by 1 point, assuming the current rates to remain stable. For the commercial business, MSFT expects another strong quarter with commercial unearned revenue down approximately 10 percent sequentially, which is in line with the historical seasonality. Commercial cloud gross margin percentage is expected to improve slightly on a sequential basis in Q1 2019. There is expectation of sequential growth in capital expenditures in the first quarter as the company continues to support growing, global customer demand. For Productivity and Business Processes, the revenue in Q1 2019 is expected to be between $9.25 and $9.45 billion on the back of double digit growth in Office Commercial and Dynamics. LinkedIn revenue growth is expected to remain high due to a stronger prior year comparable. In Intelligent Cloud, for Q1 2019, the company expects revenue to be in the range of $8.15 and $8.35 billion. Azure revenue growth is expected to reflect a balance of continued strength in the IaaS and PaaS consumption-based services and a moderating rate of growth in the per-user services. In More Personal Computing, for Q1 2019, the company expects revenue to be in the range of $9.95 to $10.25 billion. In OEM Pro, MSFT expects revenue growth in line with the commercial PC market for the first quarter of 2019 and in OEM non-Pro, the company expects similar dynamics as posted in the fourth quarter of 2018. In Surface, the company expects strong performance from the latest editions, that include the new Surface Go, to drive growth similar to corresponding quarter (Q1) of the prior year. Search ex-TAC is expected to deliver mid-teens growth in the first quarter of 2019 with consistent execution against rate and volume growth opportunities. Further, for the first quarter of 2019, in Gaming, the company expects mid-teens revenue growth due to continued strong user engagement on the platform. However, the software and services growth rate is expected to moderate due to strong third-party titles launched a year ago. Meanwhile, for the first quarter of 2019, COGS is expected to be in the range of $9.5 to $9.7 billion and operating expenses to be between $9.2 and $9.3 billion. For Q1 2019, other income and expense is expected to be approximately negative $100 million and the effective tax rate to be slightly lower than the full year rate due to the volume of equity vesting that takes place during the first quarter.

Capital Management: MSFT has declared a quarterly dividend of $0.42 per share. The dividend is payable Sept. 13, 2018, to shareholders of record on Aug. 16, 2018. The company has delivered $5.3 billion to shareholders in the form of dividends and share repurchases in the fourth quarter of FY18, which is an increase of 16% compared to the fourth quarter of FY17.

Stock Recommendation: MSFT has delivered strong performance in the fourth quarter of 2018 and first quarter of 2019 is expected to continue to deliver robust performance. Further, the company has delivered more than $110 billion in revenue for the full year 2018 with double digit growth in topline and bottom line. Considering the above, we give a “Buy” at  MSFT at the current price of $107.06.
 

MSFT Daily Chart (Source: Thomson Reuters)

 
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