Microsoft: Don’t Worry, That Spend Will Pay Off, Says Bernstein – Barron’s
Microsoft (MSFT) stock is down 97 cents, or 1.3%, at $73.25, despite what is delight by bulls with the company’s continued cloud computing growth and its free cash flow, as demonstrated in the company’s fiscal Q4 report yesterday and forecast.
Weighing in today is Mark Moerdler of Bernstein, who has an Outperform rating on the stock, and who today raises his price target to $87 from $81, pointing to higher spending as the culprit of the share drop.
As I mentioned yesterday, spending was a big focus going into the call.
Investors may be worried because the company’s outlook for operating expenses “signaled a return to investment in management’s strategy, driven by LinkedIn and the cloud business.”
“While this changes our thesis slightly, we believe the investments are due to increased opportunity on the top line, which should lead to higher than expected revenue,” he writes.
“Ultimately LinkedIn costs and incremental investment in cloud opportunities increase costs more than we had anticipated for FY 2018.”
“For example, given management’s OpEx and margin expectations, FY 2018 revenue is expected to be $106B, $3B above consensus expectations.”
“So while the acquisition of LinkedIn and increased investment in the cloud decreases some of the capital return and margin expansion opportunity, we do believe the investment is in front of increased revenue opportunity.”
As an example, Moerdler notes that Azure, Microsoft’s newer cloud offering, is becoming a bigger and bigger part of the business. That is driving down gross profit margin, but he expects Microsoft to make it up on the volume of Azure business in future:
We highlight that Intelligent Cloud revenue grew 11% (12% in CC), with Azure growing 97% (98% in CC) and double digit annuity growth. Gross profit grew 8% Y/Y (up 9% in CC), although the gross margin as a % of revenue declined due to the mix shift to more cloud combined with lower Enterprise Services gross margin was partially offset by improvement in Azure gross margin. Intelligent Cloud OpEx grew 2% Y/Y (3% CC). Intelligent Cloud operating income was up 15% Y/Y (up 18% CC). The decline in gross margin percentage is primarily due to a mix shift to Azure which is growing 98% Y/Y in CC, much faster than the on-premise server and tools business. However, scale should continue to enable operating margin expansion going forward. We would expect that at roughly AWS scale Azure should have similar margins. Microsoft’s commercial Cloud continues at a high rate and will exceed $20B run rate in FY18. The commercial Cloud is accretive to revenue and will be accretive to earnings as Azure’s margins improve. Microsoft’s Cloud footprint is gaining efficiency and scale as seen in this quarter’s YoY 1000bps margin improvement for the Commercial Cloud. As Microsoft drives efficiency and scale this will translate into margin improvements across all of Microsoft’s consumer and commercial Cloud offerings.