Microsoft Q3 – Groundwork

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The foundations of something better are being laid.

  • Microsoft reported good results as cloud and corporate helped offset the ongoing weakness in PCs.  
  • Fiscal Q3 revenues / EPS were $20.4bn / $0.68 compared to consensus at $20.4bn / $0.63.
  • Streamlining of OPEX and the transfer of a key campaign from Q3 to Q4 was mostly responsible for the EPS beat.
  • The shares are having a relief rally as cloud is managing to offset the ongoing PC weakness while Microsoft gets its house in order.
  • On that front I am increasingly confident that Nadella is not going to abandon the consumer assets meaning that this company has a future as an ecosystem provider.
  • In fact, it is the only one that is capable of offering both a consumer and an enterprise ecosystem.
  • If Microsoft can marry the two in a way that works it will be the only offering that run the Digital Life of a user at work as well as at home.
  • They key to this will be integration.
  • Microsoft needs to be able to identify a user across all of its Digital Life services not just maintain a discrete user database for every service.
  • Right now all of the different services sit in glorious isolation within their respective ivory towers and their integration represents one of the biggest challenges that Nadella faces.
  • This is essential to get the most value from Digital Life service both in terms of quality of service and monetisation.
  • So far only Google (and to some degree Apple) have achieved this.
  • Microsoft still has a lot of work to do but it seems that Nadella has decided to take the harder road to turn Microsoft into a real ecosystem company.
  • This gives much greater upside in terms of long term revenue growth but the execution risks are much greater.
  • In the last few weeks Nadella has made moves that would have been impossible a few years ago (Office in iPad, Windows for free) and this gives me hope that Microsoft can change.
  • A steady set of Q3 results and guidance lays the groundwork for a different company to emerge from under the skin of the old.
  • Microsoft remains attractively priced given the opportunity and execution risk that lie before it. 

RICHARD WINDSOR

Richard is founder, owner of research company, Radio Free Mobile. He has 16 years of experience working in sell side equity research. During his 11 year tenure at Nomura Securities, he focused on the equity coverage of the Global Technology sector.