$MSFT – Clouded by Azure

by Dan May 19, 2016 11:25 am • Commentary• Trade Ideas

Microsoft (MSFT) has enjoyed a bit of a resurgence from a relevance standpoint since Satya Nadella took the CEO helm after formerly heading the company’s cloud business.  The new found focus of Nadella on innovation and transforming legacy businesses to cloud offerings was just what investors needed to see for the stock to wake from its long slumber. Since Nadella replaced long time CEO Steve Ballmer in early 2014, MSFT has rallied more than 30% vs the S&P 500’s (SPX) 10% gains during the same period.

Despite fast growing businesses like Office 365 growing 63% in the March quarter, within the Productivity group, and with Azure (MSFT’s AWS competitor) growing 120% in the quarter within their Intelligent Cloud division, the overall groups saw just 1% and 3% year over year sales increases.  The point here is simple, while MSFT has some fast growing businesses, they are a still a small-ish part of a $90 billion revenue machine, that is NOT growing.  Following their disappointing fQ3 results, shares of MSFT declined the next day 7%, are now down 10% from the close prior to earnings on April 21st, and down almost 13% from their 52 week and 15 year highs made in late Dec 2015.  

Here is a big problem with MSFT. The stock trades nearly 19x expected fiscal 2016 eps growth of 1%, and 17.5x expected 2017 eps growth of 8%.  I am not really sure why this stock should trade at a significant premium to most mega-cap tech peers (CSCO and INTC at 12x expected 2016 eps, with low single digit growth).  Yeah, Yeah, balance sheet, capital return, and to be fair I’d rather own MSFT to consumer staples like KO or PG which have similar yields but higher valuation, but I suspect 2016 is going to see continued strain for Enterprise Tech spending, and MSFT will not be immune these pressures.

With MSFT at $50, the stock is approaching important technical support until the mid $40s, and targeting a move back to those levels in the next couple months looks attractive:

[caption id="attachment_63768" align="aligncenter" width="600"]MSFT since Jan 2015 from Bloomberg MSFT since Jan 2015 from Bloomberg[/caption]

With the stock down so much in such a short period of time I will likely wait a little bit for a short entry on a bounce, but gun to my head, this is how I express this view now:

Trade: Buy MSFT ($50) July 50 / 45 / 40 Put Butterfly for $1
  • Buy to open 1 July 50 Put for 1.65
  • Sell to open 2 July 45 Puts at 38 cents each or 76 cents total
  • Buy to open 1 July 40 Put for 11 cents

Break-Even on July expiration:

Profits: of up to 4 between 49 and 41, with max gain of 4 at $45

Losses: up to 1 between 49 and 50 & between 40 and 41 with max loss of $1 below $40 or above $50

Rationale: this trade risks 2% of the stock price and breaks-even down 2% with a wide profit potential to the downside.  The choice of July expiration is by design, as this is not a trade targeting their next earnings event which will fall in August expiration. The idea is to play for a slow bleed throughout the late spring and early summer.

I’ll be sure to follow up with this thesis, just wanted to lay out some thoughts.