Microsoft Earnings Preview: Cloud And Device Revenues In Focus

Microsoft (NASDAQ:MSFT) is set to announce its Q3 FY 2015 earnings on Thursday, April 23rd.  (Fiscal years end with June.) Microsoft is undergoing change in its business as it focuses less on the aging perpetual license operating systems business, which is dependent on the sale of personal computers, and more on the cloud business that comprises a developing ecosystem of devices and value added services. Over the course of last two quarters, Microsoft has re-stated its commitment to developing a comprehensive suite of software that extensively uses cloud technology, and is easily deployable on mobile devices. The aim is to line up Microsoft’s businesses with the changing landscape in technology, especially in enterprise software segment. During this earnings announcement, we will continue to monitor its hardware and cloud services, and expect it to report growth in all three of these verticals. In particular, we will continue to closely monitor its revenue growth from mobile devices (Windows Phone OS) and operating systems division.

See our complete analysis of Microsoft here

Cloud Products To Boost Revenue Growth

Currently, Microsoft generates $100 billion revenues annually according to our estimate. Most of its revenue stems from the sale of perpetual software licenses of products such as the Windows OS, Microsoft Office and (to enterprise clients) SQL server. However, over the past few years, changes in the IT landscape facilitated by improvement in hardware and advent of mobile devices have encouraged Microsoft to extend its services in the cloud domain. While declining demand of PCs and servers that lowers demand for its software is one such factor, other factors include price sensitivity of clients that want to cut down their costs and only pay for services that are rendered, based on the scale of operations. As a result, Microsoft has adopted cloud-first strategy to bolster its revenue in the coming years.

Its Office 365 offering continues to bolster revenues for the Windows Office division, which makes up ~40% of our estimated value. In the previous quarter, the company reported 147% growth in its cloud revenues, which includes both Office 365 and Azure sales. It enterprise mobility solutions address the growing need of enterprise apps that makes employees productive when they are on the move. We believe that these steps will augur well for the company and help it in maintaining its market share in the future.

In Q2 2015, Microsoft reported that Office 365 had over 9.2 million subscribers and the revenue from this cloud offering in the quarter more than doubled year over year. As subscription model for office sets in, revenues for this division will be recurring and thus more predictable going forward. Currently, we estimate that the company has close to 93% share in productivity software market. In the upcoming earnings announcement, we expect Microsoft to report increase in subscribers and revenue run rate for Office 365 as its clients adopt the feature-rich, cloud-based Office software. We anticipate that Office 365 will attain a greater than $1.8 billion annual revenue run rate as its clients adopt the feature-rich, cloud-based Office software.

Microsoft’s Windows Server division is the second largest business unit, making up over 24% of its total value. The strong adoption of cloud-based Azure platform continues to drive growth at the server division as the company continues to form partnerships with companies such as Salesforce.com to boost its portfolio of services. During the Q2FY15 results, Microsoft CEO Satya Nadella said that Microsoft’s cloud computing business (which includes revenues from Azure, Office 365 and Dynamic CRM online) is on track to generate $4.4 billion in revenue this fiscal year , if sales keep up the way they’ve been going. We believe that the Azure platform will be a key growth driver for Microsoft going forward, as companies around the world are looking to lower costs by adopting cloud-based services.

Additionally, many Microsoft customers depend on SQL servers for mission critical and business intelligence needs, specifically in the big data analytics domain. The company can leverage the popularity of its SQL server and Azure platform to sell its recently launched Business Intelligence tools. We expect the server division revenues to get a boost due to the bundling of these services.  Accordingly, we believe the company will report good growth in revenues in this quarter as well.

Mobile Device Sales To Boost Hardware Sales

Microsoft is increasingly pursuing its devices and services strategy to reduce its reliance on PCs and expand its footprint in the mobile hardware domain. In Q2 FY15 (Dec ending quarter), Microsoft sold 10.5 million Lumia phones and over 39 million non-Lumia phones, which translated into $2.28 billion sales and $331 million in gross profits. Going ahead, we expect this division to do well, and Microsoft to report higher sales. However, since the company is focusing on selling Lumia at lower price points, and in emerging markets, we expect revenues to be lower and profitability to decline. Furthermore, it announced the launch of two low price variants of laptops that will go on sale in mid of 2015. ^[1] This launch will coincide with the launch of Windows 10. In this earnings announcement, we will closely monitor Microsoft’s phone and tablet unit sales. In particular, we will monitor revenue numbers for its devices and consumer hardware segment to ascertain the popularity of Microsoft’s devices in emerging markets.

PC Sales To Affect Windows OS Sales

The Windows Operating System (OS) is Microsoft’s third largest division and makes up around 10% of its stock value, by our estimates. Recently, this division has reported growth in revenues, primarily due to Microsoft’s termination of support for Windows XP, which is forcing laggards to upgrade from this popular OS. Recent data from IDC indicates that PC shipment declined by 6.8% in Q1 2015 as clients deferred buying new PCs in anticipation of Windows 10 launch, which will be launched in Mid of 2015. ^[2] While we expect new PC shipments, together with the existing installed base of Windows PCs will help Microsoft post growth in license sales during the quarter, disappointing PC sales might temper the revenues. In this earnings announcement, we will continue to pay close attention to the numbers of licenses of Windows sold in both desktop and mobile verticals.

We have $44.46 price estimate for Microsoft, which is 8% higher than the current market price.

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1. Read about it here [↩]
2. PC Shipments Beat Expectations Despite Weak Currencies and Product Transitions, According to IDC, April 09 2015 [↩]