Sunday, March 23, 2014

Barron's - Microsoft Trades Higher In June

Tech Trader: The Best Opportunity For Microsoft
Shareholders In Years -- Barron's
Mar 22 at 00:09
By Tiernan Ray

      (FROM BARRON'S 3/24/14)
      Microsoft's quixotic journey from dog to darling took another curious turn
last week as reports floated around that the company will make its Office
productivity suite available on Apple's iPad at a media event it is hosting this
      The Street has been waiting to exhale over this announcement for years,
and in fact the apparent unwillingness of the company to ship product on Apple's
(ticker: AAPL) tablet was one of many bones shareholders had to pick with former
CEO Steve Ballmer. The stock (MSFT) is up 47% in the past year, to a recent $
40.16, with the shares hitting multiyear highs last week.
      Assuming it happens, Office for iPad will be a good thing for Microsoft,
but it won't be the answer to the company's future. CEO Satya Nadella, a
Microsoft veteran, holds the keys to the future in his distinguished career
running Microsoft's cloud-computing business. That business, not Office, is the

      The fixation with Office is understandable. Not only is it one of
Microsoft's most visible, and beloved products, it's also an enormous cash cow,
bringing in perhaps $22.25 billion of Microsoft's $78 billion in revenue in
the last fiscal year, according to analysts. A number of those following the
stock predicted last week that a version for the iPad could boost sales of
Office to consumers, who have typically represented a smaller portion of Office
revenue, which is really more of a corporate product.
      Nomura Equity Research's Rick Sherlund estimates it might add a billion
dollars in annual revenue to Microsoft's income statement. Jefferies' Ross
MacMillan, another Microsoft bull, went further, predicting incremental revenue
of as much as $4 billion annually, perhaps adding $2 to $4 per share in
value to Microsoft's stock. MacMillan deems Office the most valuable of all
Microsoft's businesses, worth $23 per share, assuming the new version sells
      But adding $1 billion or even $4 billion, annually, or boosting the
share value by a couple bucks, is not going to transform a company that for
years has meandered as the personal-computer market has succumbed to the world
of mobile and always-on, Internet-connected devices. Tech companies rise or fall
by how they anticipate developments in the industry that can be commercialized
even before people know they need them. It happened once for Microsoft with the
PC, and it can happen again with cloud computing.
      Microsoft has never been a consumer company. Its roots are in selling
tools to software developers, the success of the highly geeky Xbox game console
notwithstanding. As Barron's has written, the entire world of software is moving
away from bits shipped on disk to bits served up from a Website, either as an
app on your phone, or as a Web page with the ability to perform increasingly
complex tasks ("Building the Cloud: Who Wins, Who Loses," Oct. 14, 2013).
      So far, that business is dominated by (AMZN), which hosts
applications for developers large and small for a fee. That business should be
Microsoft's business. Start-up Cloud Technology Partners, which does consulting
work for companies developing for the cloud, tells me that Microsoft is a strong
second-place performer in cloud, behind Amazon, in terms of the amount of
interest and activity from clients, while Google (GOOG) is also drawing lots of
      Exact data on revenue from cloud aren't available for the three. By some
estimates, Amazon is far and away the leader, with perhaps as much as $7
billion in revenue from its Amazon Web Services expected this year. Nomura's
Sherlund estimates Microsoft is getting about $3 billion from the cloud
annually. Another estimate, provided by Mark Moerdler of Sanford C. Bernstein,
has Microsoft making $1.29 billion in cloud computing in the fiscal year ended
last June, and perhaps $2.62 billion or more this year.
      Figures are fuzzy depending on which products are included in different
estimates. For example, in Sherlund's estimate, much of the revenue appears to
be from the cloud-based version of Office sold to companies. Which is fine; it's
nice to have a very successful marquee software product moving to the cloud. But
there's a larger opportunity as more and more software applications generally,
not just Microsoft's, move off of company-owned computers, into public cloud-
computing data centers such as Microsoft's Azure.
      The current market for tools to develop cloud applications is a mess. It
is dominated at the moment by companies large and small other than Microsoft,
including Red Hat (RHT); Pivotal Labs, a spinout of EMC (EMC) and VMware (VMW);
start-ups such as Engine Yard; and Amazon's own offerings. That means there is a
lot of choice for developers, and also a lot of potential confusion.
      According to Cloud Technology Partners, the market is in an early,
evolutionary phase, with Pivotal leading at the moment. At some point, they
predict, it will coalesce around a few top tool vendors.
      That is Microsoft's opportunity. Or it should be, if Nadella can give the
company the right focus. By providing tools to developers to make Web apps,
Microsoft might not own the future of application development, but it could
certainly be one of those top two or three vendors. "This is a huge
opportunity," says Sherlund. "What encouraged me is that Satya has run this
business," meaning Azure. "He gets it."
      Current and former staffers were in fact frustrated by Ballmer's
unwillingness to let the company move more quickly to the cloud. But the
opportunity is not lost, says Sherlund, as the practice of developing for the
cloud "is just getting started."
      Sherlund predicts some hiccups for revenue and profit margins, as sales of
Microsoft's products shifts from up-front payments to a subscription model. But
he points out Adobe Systems (ADBE) in the past year has made a similar move to
subscriptions very quickly, and it hasn't hurt the shares, which are up 59% in
the past 52 weeks.
      "You'll go from Microsoft being valued at maybe 10 or 12 times cash flow
to perhaps five times revenue," he wagers, because cloud revenue can have a
higher growth rate than the traditional business. That would be a bump up from
the current multiple of about four times trailing revenue.
      Sherlund predicts the move to cloud tools won't happen at this week's
media announcement, but rather when Nadella has his next meeting with the board
of directors, which Sherlund expects will be in June. If he's right, and Nadella
is ready to take the company in such a bold new direction, it could be the best
news for shareholders in a long time.
      Tiernan Ray can be reached at or at techtraderdaily or
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  (END) Dow Jones Newswires
  03-22-14 0009ET
  Copyright (c) 2014 Dow Jones & Company, Inc.

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