Current Price: $203 Price Target: $224
Position Size: 7.5% TTM Performance: 78%
Key takeaways:
· Broad beat – MSFT beat on revenue and EPS. Total revenue growth was +12% – they beat estimates and the high end of guidance in all segments.
· Weak guidance – The negative in the quarter was guidance which was slightly below expectations (similar to last quarter). Long-term drivers and positioning still very strong.
· Cloud strength continues to be a key theme – commercial cloud surpassed $50 billion in annual revenue, +36% YoY. Azure revenue was in line w/ expectations at +48% growth.
· CEO, Satya Nadella said, “ in a world of uncertainty and constraints, every person and every organization needs more digital technology to recover and reimagine what comes next. This represents an unprecedented expansion of our addressable market in every layer of the tech stack.”
Additional Highlights:
· Transactional licensing business remained a headwind, although the small and medium business customer segment improved slightly through the quarter.
· Improvement in advertising market benefited Search and LinkedIn
· Company gross margin percentage was up 2 pts YoY to 70%, driven that was driven by an accounting change (noted below). Excluding that, gross margins were down slightly, b/c of increasing cloud revenue mix and also b/c of “trial offers” and flexible financing options in response to the “challenging environment.” Excluding the accounting change, op margins were up by 2pts.
· Productivity and Business Processes ($12.3B, +11% YoY):
o Cloud usage and demand increased as customers continued to work and learn from home. Transactional license purchasing continues to be slow, particularly in small and medium businesses. LinkedIn saw improvement w/ revenues +16%.
o Strength especially w/ Office 365 Commercial (up 21%), Dynamics 365 (up 38%). Office 365 Commercial growth driven by installed base expansion as well as higher ARPU.
o Dynamics 365 is helping organizations in every industry digitize their end-to-end business operations from sales and customer service to supply chain management. Mercedes-Benz is using Dynamics 365 Remote Assist to help technicians across its US dealerships service increasingly complex cars, faster. And BHP is using the solution to keep employees at mining sites in rural Australia safe.
o MSFT recently announced a partnership with C3.ai and Adobe to bring to market a new class of industry-specific CRM solutions powered by Dynamics 365. It’s their first industry-specific cloud (“Microsoft Cloud for Healthcare”) which will become available later this week. It brings together healthcare-specific capabilities from across Dynamics 365 as well as Microsoft 365 Power Platform and Azure to help providers like Cleveland Clinic and St. Luke’s Health Network improve patient outcomes.
o Teams product is really shining for them right now – they reported 115m daily active users, up from XX in April and 32m before the pandemic started. Teams advantage is its broad integrated user experience. The fact that it’s sold bundled w/ MSFT’s other productivity offerings and its interoperability are key to its positioning. For example, Dynamics 365 can connect to Teams so that you can incorporate customer information and analytics. Teams is about actually getting work done where meetings and video is just one part – as such, its utility should increase w/ mixed office and WFH environment in the future.
o Seeing an acceleration in Office E5 licenses – that’s the highest license tier.
· Intelligent Cloud ($13B, +20% YoY):
o Cloud usage and demand increased as customers continued to work and learn from home.
o Server products and cloud services revenue increased 22% with Azure revenue growth of 48% driven by continued strong growth in their consumption-based business.
o “We are building Azure as the world’s computer with more datacenter regions than any other provider, now 66, including new regions in Austria, Brazil, Greece, and Taiwan.” In the previous two quarters they added Italy, New Zealand, Poland, Mexico and Spain.
o Power Platform (low code/no code solution) now has more than 10 million monthly active users, at more than 500,000 organizations from Ikea to Toyota. PayPal, for example, is using Power BI within Teams to expand access to data insights.
o Lockheed Martin is using Azure mixed reality and HoloLens to speed up the development of the Orion spacecraft.
· More Personal Computing ($11.8B +6% YoY):
o Surface (+37%) and Gaming (+22%) benefited from increased demand to support “work, play, and learn-from-home” scenarios, while Search (-10%) was negatively impacted by reductions in advertising spend. Seeing headwinds from SMB spending. Also offset by declines in Windows OEM revenue (-5%) on a difficult prior-year comparable that benefited from the end of support for Windows 7.
o Xbox content and services revenue increased 30%. Xbox Game Pass service has more than 15 million subscribers.
o Windows Commercial products and cloud services revenue increased 13%
· Commercial Cloud ($15.2B, +31% YoY)
o “Commercial cloud” aggregates the cloud businesses w/in the first two segments: Office 365, Azure, the commercial portion of LinkedIn, Dynamics 365.
o Gross margin percentage increased 5 points YoY, from 66% to 71% due mostly to an accounting change, and some improvement in Azure gross margins.
o
Valuation:
· FCF was $14.4 billion. They returned $9.5B to shareholders w/ $5.3B in share repurchases and $4.2B in dividends an increase of 21% vs Q120.
· Recurring revenue is ~60% of total, underpins most of their valuation and is resilient and poised for additional growth. Particularly Azure, Office 365 and Dynamics 365. Stock is trading at >3% FCF yield on 2021 (ends in June).
Sarah Kanwal
Equity Analyst, Director
Direct: 617.226.0022
Fax: 617.523.8118
Crestwood Advisors
One Liberty Square, Suite 500
Boston, MA 02109
$MSFT.US
[category earnings ]
[tag MSFT]