Microsoft (NASDAQ:MSFT) is one of that select group of companies whose value is counted in the trillions – roughly $1.3 trn currently. Results for the year to 31st December 2019 showed revenue up by $36.9 bn, an increase of $14bn, and earnings per share at a $1.51, a 40% increase.
But on 26 February 2020, the company warned that it was not expecting to fulfil its third quarter sales forecast at its personal IT division, which markets Windows, Surface devices, and Xboxes. $63 bn was wiped off the company’s value, with the shares falling 7.1%, 2020 at $158.18. So let’s take a look at how the company is placed to deal with the challenges in its environment.
Microsoft has managed to keep its software offerings relevant, despite its long term presence in the technology industry. From Office 365 to its Azure commercial cloud activities, it’s the dominant market presence when it comes to software. In addition, the cloud services business continues to grow strongly.
Part of the reason for this is that Microsoft is a trusted brand, both in corporate boardrooms and in the home and small business sectors. Personal users are comfortable with the MS software suites and disinclined to learn new packages. As an example, for Windows 10 alone, there are an estimated 700 million installations worldwide, and an even higher number of users.
Add to this, that Microsoft doesn’t make its money primarily from monetizing its users’ data, in the way that Google and social media companies do. So it attracts far less official criticism than these organisations, in terms of its business model and governance. In fact, the company features in many ethical investing strategies.
Microsoft has successfully adopted the Software as a Service (SaaS) business model, and alongside other business services, its Office 365 customers have happily signed up to a subscription-based service. This steady income stream is great for the company’s cash flow, and it really has no competition in this area.
Long gone are the days when the company’s Internet Explorer was the most popular browser on the planet. Microsoft’s IE and Edge browsers have continued to lose ground to their rivals at Google Chrome and Firefox. Computer World reports that whereas Chrome has 69% of the browser market, Edge has just 4.6%.
However, in a revolutionary move, Microsoft’s new version of Edge is based on the open source code that Google used to build Chrome. This should enable users to access add-ons for Edge that are currently only available in Chrome. The new version of Edge is garnering good reviews, so it’s possible that this weakness may resolve itself. It may even enable Microsoft to take back some competitive advantage in the PC environment, which is a mature market where it is difficult for the company to push growth.
In the past, Microsoft has been slow to innovate, and initially missed opportunities to capitalise on the internet revolution. These indicate a corporate culture that fails to give enough weight to strategic planning and horizon scanning, although there are signs of change under CEO Satya Nadella.
There are huge opportunities for Microsoft in AI and innovative uses of digital technology. This is especially true when it comes to the application of these technologies in areas such as health. Microsoft doesn’t have the privacy issues that dog the social media companies, and may be seen as a preferred provider when security and confidentiality are important. The Times reported in February 2020, that last year Microsoft spent $1.6 bn acquiring small companies that showed future promise in these areas.
Cloud-based technology, including MS Azure, and the Dynamics 365 suite also offer significant global growth opportunities. Azure income appeared to be slowing this year, but that was from previously sky high rates. Surface PC and gaming sales also boomed last year.
Then there are the huge contracts available from governments, for updating national IT systems. Microsoft has landed a $10 bn contract from the US Department of Defense. The work will involve setting up Cloud technology to service the Joint Enterprise Defense Infrastructure (JEDI), and updating the technology used by the Pentagon.
There are few competitors able to work at this scale. While Amazon Web Services has more cloud customers, it can’t offer Microsoft’s combination of Azure cloud services, with a fully integrated and familiar suite of applications. And if the Pentagon trusts Microsoft’s cloud services security, why wouldn’t other large scale government departments, in countries across the globe? However, this win has not gone unchallenged, as we’ll see when looking at threats to Microsoft’s future business.
At the time of writing, COVID 19 poses a threat to many commercial supply chains, especially for companies such as Apple that use Chinese production companies. Microsoft also uses Chinese factories to assemble its products. However, sales in China only account for around 2% of Microsoft’s revenue. More of a threat, is a generalised economic slowdown, caused as much by fear of the virus, as by its actual effects.
Secondly, much of Microsoft’s reputation rests on its reliability. Early in 2020, a Windows 10 update ended in fiasco, with some users’ data appearing to be deleted (although it was later restored). Poorly tested PC Windows updates and patches cause reputational damage that can affect other parts of the business.
And while Microsoft was still celebrating the JEDI contract with the US Defense Department, having defeated Amazon, Amazon went to court to challenge the contract award. Possibly, Amazon may feel that President Trump’s antagonism to Jeff Bezos, their CEO, may have influenced the decision to give the contract to Microsoft. However, the court papers don’t mention this, relying instead on attacking Microsoft’s technology as inferior and offering worse value to the government.
Analysts surveyed by Nasdaq in the last three months are targeting a price of $197.73, with a low of $174 and a possible high of $212. Elsewhere, broker consensus is solidly behind buy recommendations.