Event: Microsoft (MSFT) reports fiscal Q4 results tonight after the close. The options market is implying about a 4.5% one day move, which is well below the 4 qtr average one day move of about 6.6%, and inline with the 10 year average of about the same. It’s important to note that on two instances in the last 5 quarter the stock has rallied 10% the day after earnings and decline 9% six quarters ago.
Price Action / Technicals: Shares of MSFT are down 3.5% on the year, up about 10% from its 2016 lows made in February, and down about 6% from its 52 week and 15 year highs. The chart from the start of 2015 shows two fairly well defined trading ranges, the first between $40 and $50ish from Jan 2015 to Oct 2015 and then the epic breakout creating a new trading range between just below $48 and $57:
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From Bloomberg[/caption]
But tech investors have long memories, and while the stock has clearly lost some momentum since being rejected in April from making a new high, there are those who are still eyeing the 2000 dotcom bubble high at $60:
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From Bloomberg[/caption]
Hot topics:
Cloud transition & expected growth: 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
Playing catch up with Azure to Amazon’s AWS in Public Cloud: We know that AWS’s 28% operating margins is a large contribution to AMZN’s new found (albeit slight) profitability. But margins have declined (also slightly) in the last two quarters. Why? Well, it could be simply that MSFT and GOOGL are becoming more competitive on pricing. When it comes to MSFT it is widely thought that their Azure business is. Despite growing 120% year over year in their latest quarter (fiscal Q3), operating margins in the Intelligent Cloud group (total revenue of $6 billion in fQ3) where Azure is bucketed, saw operating margins badly miss expectations of about 40%, coming in at 35.9%. This could signal a more aggressive tone by MSFT in an attempt to gain market share from AWS.
Valuation: The stock trades nearly 20x expected fiscal 2016 eps growth of 1%, and 18.5x expected 2017 eps growth of 8% (likely high). I am not really sure why this stock should trade at a significant premium to most mega-cap tech peers (CSCO and INTC at 13x 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.
Acquisition of Linkedin (LNKD): As you may recall, Microsoft (MSFT) agreed to pay $26.2 billion in cash to acquire LinkedIn (LNKD). I am sure MSFT has some pretty good reasons for paying 7x expected sales for LNKD, sales that are expected to grow 25% in 2016 to $3.7 billion, but on growth that has decelerated from 35% in 2015, 45% in 2014 and 55% in 2013.
While this is a clear indication of MSFT’s intent to pivot from their reliance on PCs, its not entirely clear how such an expensive and dilutive deal will benefit shareholders in the next couple years, especially when you consider how bad MSFT has been in the last decade with large acquisitions (see aQuantive, Skype & Nokia). I suspect this deal could be a massive distraction for the company and investors, especially when you consider MSFT suggests the company will continue to operate as a standalone by its existing management.
MY TAKE: Q2 PC dated improved after quarters of yoy declines (read here), which could be incrementally positive. Back in late May when the stock was $50 Cowen’s Software analyst Gregg Moskowitz slapped a buy rating on the stock with a 12 month price target of $58 suggesting a potential inflection point in their core Office business, per Barron’s:
Largely overlooked in the F3Q report is a critical turning point in MSFT’s transition of Office to a subscription. Specifically, total consumer and commercial Office revenue – perpetual and subscription combined – each grew on a y/y reported basis, reversing a series of declines that have occurred during the model transition. We are confident that Office revenue will grow in FY17, and accelerate further in FY18.
That’s all fine and good, but I suspect given the company’s attempt at a transformational acquisition may cause some investors to remain skeptical about incremental improvements in legacy businesses as they will be keenly focused on market share in public cloud and margin growth in private cloud offerings.
In front of earnings, I am NOT a buyer playing for a breakout to the prior 52 week and all time highs. I suspect the quarter will be messy as the enterprise tech spending environment might have softened into the late June Brexit vote, while the surge in the dollar back to 4 month highs in the aftermath might put a lid on upside guidance as 55% of their sales come from outside the U.S. and LNKD to be a potential distraction.
Estimates & Forecasts from Bloomberg:
-4Q adj EPS est. 58c (range 55c-65c)
-4Q rev. est. $22.13b (range $21.80b-$22.58b)
Rev. ests. by business unit:
-More Personal Computing $8.87b (4 ests. compiled by Bloomberg); April 21 forecast $8.7b-$9b
-Intelligent Cloud $6.58b (4 ests. compiled by Bloomberg News); forecast $6.5b-$6.7b
-Productivity and Business Processes $6.64b (4 ests. compiled by Bloomberg News); forecast $6.5b- $6.7b