Mar. 23, 2016 4:41 PM ET| About: Microsoft Corporation (MSFT)
Michael Grogan Michael Grogan⊕Follow(552 followers)
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Summary
1 Microsoft Corporation has continued to trail higher in both price and valuation.
2 It has become increasingly clear that cloud will dictate the future of this company.
3 The key challenge for Microsoft is differentiation of cloud services.
4 Should cloud services become increasingly commoditized, then this could spell trouble for the company.
In my last analysis of Microsoft Corporation (NASDAQ:MSFT), I argued that the company stood to either grow or decline significantly in the coming months. With the company trading at premium valuations, investors are clearly expecting big things from Microsoft and anticipating that the company will deliver on its promises. In the last month, we see that both price and valuation (relative to earnings and cash flow) have continued to rise:
prise
Price-to-earnings
Price-to-free cash flow
However, I must admit that I had somewhat misjudged the main drivers behind such growth. Previously, I had argued that desktop-based products such as Windows 10 have been significant drivers behind growth for the company. However, Windows 10 actually accounted for only 10 percent of the company's overall revenue. Instead, server and cloud-based sales have been the main driver of cash generation for Microsoft.
Moreover, I had pointed out that Office 365 had been performing significantly well for Microsoft. However, it is the cloud-based capability of this product that has helped bolster sales. While I had expressed concern that low mobile sales could be a threat to Microsoft, this is not the company's main ball game. Even Steve Ballmer has acknowledged that Android has the upper hand in mobile applications, and Windows phones would need to run the Android platform to be competitive.
Therefore, as we go forward, we can expect that Microsoft will increasingly focus on cloud services as a focal point of its overall business. Specifically, Microsoft has kept its eye on the fact that the primary users of its products are not average Windows users like you or me - they are small and large-scale businesses. Indeed, the main draw behind Microsoft at this point in time is that services like Office 365 and Visual Studio for application development have now become cloud based. This means that collaboration which could have only previously taken place across individual machines are now centralized in the cloud - this is a big draw for companies which are already heavily invested in Microsoft software.
Specifically, while Amazon Web Services (NASDAQ:AMZN) has had the first-mover advantage in developing its cloud ecosystem, Microsoft could end up becoming the second mouse that gets the cheese. Microsoft's main advantage in this context is product specialization, with cloud-based service Azure providing access to specialized products such as Cortana, Visual Studio, Microsoft Sharepoint and Windows Server, among others, while providing access to more mainstream programming tools such as API, Hadoop and SQL. In this regard, I see Microsoft's success as critically resting on how much further the company can differentiate its cloud-based offerings. For businesses that have already invested significantly in Microsoft, this could mark a big opportunity for the company to take back market share from Amazon, which currently leads in this market:
Source: Statista
So, to revisit the original question - can Microsoft keep growing at these rates? My answer is that it depends on the degree of differentiation of the company's cloud services. Should Microsoft succeed in integrating its specialized software as part of a broader cloud ecosystem, then the company could well outperform its competitors and grow further. However, there also is the risk that cloud services could become increasingly commoditized, in which instance I would expect that current levels for Microsoft will become unsustainable.
Cradit By"http://seekingalpha.com/article/3960590-microsoft-investors-betting-cloud-can-stock-reach-stars"
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