- Dominant position in several markets
- Differentiated consumer exposure
Of all the big tech businesses, Microsoft (US:MSFT) is best placed to weather the upcoming recession. Unlike its rivals it barely relies on advertising revenue. Instead, it sells essential software to businesses. Advertising budgets are one of the first to be cut in hard times; IT budgets are the last.
Tech giant Meta (US:META) recognizes Microsoft’s leading position. It has turned to Microsoft as a partner to provide the enterprise software for its new virtual reality headsets Quest Pro and Quest 2. Meta owns the leading hardware in the industry but has been criticized for the quality of its user interface. It sees Microsoft’s decades of experience as the solution. Users will be able to stream any Office 365 product from the Azure cloud onto their Meta headset.
Mark Zuckerberg firmly believes virtual reality is the future of computing, but Microsoft is still benefiting from the growing demand for traditional computing. The pandemic accelerated businesses’ digital transformation, with Microsoft’s annual revenue jumping 39 per cent from $143bn (£120bn) in 2020 to $198bn in 2022.
Increased scale improved profitability. Operating margins rose from 37 per cent in 2020 to 42.1 per cent in 2022. This was Microsoft’s highest ever operating margin and it was achieved despite a $6.3bn increase in operating expenses due to investment in cloud engineering, LinkedIn and gaming.
The spending on cloud engineering is paying off. In the first quarter of 2023, intelligent cloud revenue rose 20 percent to $20.3bn on an annual basis. It now makes up 41 percent of total revenue. The results don’t split out Azure’s revenue from the other cloud services – but it grew at 35 percent, a rise of 42 percent on a constant-currency basis. That beats its biggest rival, Amazon Web Services.
The gaming investment has gone towards a new cloud gaming project called Xbox Game Pass. Users pay a subscription fee to stream games onto their console rather than having to purchase them individually. The company has been coy with exact revenue and subscriber figures. However, on the recent earnings call, chief executive Satya Nadella revealed that subscriber numbers had grown 159 percent year on year.
Taking a two-year view, things are going well. However, as with most tech companies the last six months have been difficult. Given the amazingly high expectations for cloud computing, Azure’s 35 percent annual growth in the first quarter of this year fell below analyst expectations of 36.5 percent, as customers scaled back their usage to save on costs. Chief financial officer Amy Hood said Azure growth would slow again next quarter.
The consumer portion of the business fared worse. Personal computing revenue decreased very slightly to $13.3bn. This was driven by “PC market demand deterioration” but was partially offset by the strong demand for Xbox consoles – with gaming hardware revenue rising 13 percent. Customers are happy to stick with their old PCs for longer before replacing them, but gamers clearly view the next-generation consoles as an essential good.
Nadella sees gaming as the most promising consumer market. Unlike Amazon (US:AMZN) and Apple (US:APPL), Microsoft has steered clear of video streaming while investing heavily in gaming software and hardware. At the beginning of the year, Microsoft brought Activision Blizzard for $68.7bn and despite regulatory scrutiny Nadella still expects the deal to go through. Activision is one of the largest game developers in the world and owns massive franchises such as Call of Duty which will soon be available on Xbox Game Pass and Meta’s Quest headset.
Microsoft is one of the most expensive big tech companies, trading on a FactSet broker consensus forward price/earnings (PE) ratio of 24. Google is trading on 18, Meta 14 and Apple 23. Amazon’s low-margin business is the only one on a higher PE ratio.
There is justification for Microsoft’s price. It doesn’t have nearly as much exposure to advertising as Google and Meta, which rely on it for almost all their revenue. Meanwhile, Amazon and Apple are both heavily reliant on consumers’ financial well-being.
However, companies need software to function. It’s a utility that can’t be cut off and the bet on gaming looks prudent. The Chinese Communist Party introduced restrictions on gaming last year after comparing its addictiveness to heroin. This might be an exaggeration, but the growth of Xbox sales is striking amid the wider economic turmoil. Out of all the big tech businesses, Microsoft is the best bet.
| MSFT-US | ||||
| Company Details | Name | Mkt Cap | Price | 52-Week Hi/Lo |
| Microsoft Corporation (MSFT) | $1,802bn | $241.68 | 34,967c / 21,343c | |
| Size/Debt | NAV per share* | Net Cash / Debt(-)* | Net Debt / Ebitda | Op Cash/ Ebitda |
| 2,234 c | $30.1bn | – | 105% | |
| Valuation | Fwd PE (+12mths) | Fwd DY (+12mths) | FCF yld (+12mths) | CAPE |
| 24 | 1.1% | 4.0% | 48.1 | |
| Quality/Growth | EBIT Margin | ROC | 5yr Sales CAGR | 5yr EPS CAGR |
| 41.7% | 34.5% | 15.6% | 24.3% | |
| Forecasts/Momentum | Fwd EPS grth NTM | Fwd EPS grth STM | 3-month Mom | 3-mth Fwd EPS change% |
| -8% | 18% | -17.0% | -2.2% | |
| Year End 30 Jun | Sales ($bn) | Profit before tax ($bn) | EPS (c) | DPS (c) |
| 2020 | 143 | 53 | 576 | 203 |
| 2021 | 168 | 71 | 797 | 223 |
| 2022 | 198 | 84 | 921 | 245 |
| f’cst 2023 | 213 | 88 | 951 | 261 |
| f’cst 2024 | 241 | 102 | 1,118 | 281 |
| chg (%) | +13 | +16 | +18 | +8 |
| source: FactSet, adjusted PTP and EPS figures | ||||
| NTM = Next Twelve Months | ||||
| STM = Second Twelve Months (ie one year from now) | ||||
| *Includes intangibles of $79bn or 1,057c per share | ||||
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