Microsoft’s Single-Minded Focus – Seeking Alpha
Microsoft (MSFT) has a lot of growing parts, not the least of which is its cloud segment. However, these parts seem disparate, albeit growing at healthy paces on their own. But what is the cohesive element that binds these diversified offerings? And how does that support Microsoft’s long-term growth potential? More importantly, does it offer an upside that is only just emerging from the seeming mess of successful products?
At first look, Microsoft’s cloud product portfolio looks like it is made up of several different types of software, hardware and services sold by a single company. Office 365, Dynamics 365, Azure, server products, enterprise services, product support, LinkedIn and so on – many items addressing many different needs.
But if you look closely, you will notice that, bit by bit, Microsoft has been going after one single market with all of these seemingly disparate products, and that’s the enterprise segment. Microsoft has painstakingly built a portfolio of products that addresses most of the software requirements of enterprises and smaller businesses. We can do without a desktop at home, but that’s not likely to happen in our offices. A few years down the road, even Windows is very likely to become a product that is focused on enterprise users rather than individual consumers.
Microsoft announced a few years ago that the company is targeting $20 billion in annual revenues from cloud by 2018. During the fourth quarter of 2017, Microsoft’s cloud revenue run rate exceeded $18.9 billion, and if the current rate of growth continues, Microsoft will make a lot more than $20 billion in annual revenues from cloud by 2018.
Source: Chart Created by Author using Microsoft Quarterly Earnings Release
The growth in competition should have affected a big player like Microsoft, but in reality, cloud revenue run rate has grown at an extremely steady pace in the last two years, and even saw a slight uptick in the last few quarters. There are several factors in play that will help Microsoft to keep setting the cloud revenue growth pace for the industry, and these factors also will keep the company at the top of the cloud industry in terms of overall revenue.
What are these enterprise-focused products that will help Microsoft achieve this extremely difficult goal with ease, and what are the reasons underlying their strength?
Office 365 Has No Real Threat
For so many years, Microsoft’s Office suite remained the go-to application for big companies and small businesses around the world. As they transitioned to cloud, the company put its expertise to good use creating cloud-based equivalents of its most popular software products.
Office 365 faces no real competition in the market at this point because there are no rival product bundles that can match the breadth of its productivity application. Case in point: there are currently over 100 million subscribers using Office 365 from the commercial segment alone, which doesn’t count consumers.
Source: Microsoft 2017 Annual Report
The further Office 365 grows, the harder it will become for the competition to catch up. Why would any company that has used Office 365 ready to take the pain of migration, when what the competition offers is more or less the same? The odds of a competing product capable of offering much more than what Microsoft Office offers are extremely slim, because if such a product did come out, Microsoft would move heaven and earth to match it.
That leaves pricing as the only weapon that can be used for making the case for migration. Microsoft’s Productivity and Business Processes segment sits with a fat 30%-plus operating margin, so that weapon is as good as useless against Office 365.
Office 365 is Microsoft’s biggest strength right now, and it will be ten years from now as well, and it is primed for the enterprise segment.
This is the search result I got when I used Google Search for “Microsoft Office competitors.” Not a great list, and certainly not one that is going to keep Microsoft’s management awake at night.
Azure’s Growth Rate is Near Triple Digits
Microsoft Azure is the second largest player in the Infrastructure as a Service market. No one really knows how much revenue Azure makes, but it’s clear that it is far less than that of Amazon’s (AMZN) AWS because Microsoft’s overall cloud revenue run rate – which includes all their cloud products – has only just gone past $18 billion, while Amazon’s infrastructure-focused AWS is already above $14.5 billion in trailing twelve months revenue.
The gap between Azure and Amazon Web Services is wide, but Microsoft has managed to keep Azure growing at near triple-digit speeds for the last two years. During the fourth quarters of 2017 and 2016, Microsoft’s Azure revenue grew 97% and 102%, which means that for every dollar Azure made in the fourth quarter of 2015, it made nearly four dollars during the fourth quarter of 2017. That’s not a bad place to be if you are playing catch up in a market where every major tech company is fighting to make its own name in the game.
Things will slow down as Azure keeps getting bigger in terms of revenue, and it will eventually have to arrive at the current 40% to 50% revenue growth range that the more mature AWS is hitting. But the current growth rate of Azure makes it clear that the company is still a few quarters – or at least a year or two – away from when growth rates start moving lower.
Windows is the Foundation for Microsoft Cloud in the Enterprise World
It might surprise you that I include Windows as one of Microsoft’s strengths in cloud, but the reality is that the world’s most popular desktop operating system will play a crucial role in Microsoft’s pursuit of enterprise software dominance.
As I mentioned, desktops are going to be the mainstay of office environments for the foreseeable future, unlike the home consumer whose need for a PC is limited to niches like gaming or running intensive applications.
So desktops aren’t going away at work, which means Windows will remain the dominant OS. For Microsoft, it makes things easier from a product development perspective because they only have to focus on applications running on its own native operating system. As an example, Microsoft can offer much deeper application integration with Windows rather than Apple’s (AAPL) macOS or Google’s Chrome OS.
Dynamics 365 and LinkedIn are Being Deeply Integrated
Dynamics 365 is Microsoft’s answer to Salesforce.com’s (CRM) CRM offering and Oracle’s (ORCL) ERP suite. Microsoft bought LinkedIn mainly to help jump start these two segments of its enterprise software applications business. That much is amply clear with the many integrations that were recently announced between Dynamics 365 and LinkedIn Sales Navigator. Microsoft clearly wants in.
Salesforce.com is still growing its quarterly revenues at well above the 20% mark, and catching up is easier said than done, and Oracle already is hitting above 50% sales growth in the Software as a Service segment. But Microsoft also has picked up speed in the last two quarters and Dynamics revenue grew 81% and 74% during the third and fourth quarters of the current fiscal, on a year-over-year basis.
I do expect Microsoft to keep moving faster than Salesforce.com and Oracle are, in their respective segments, until it closes the gap considerably. There’s still a long way go, but Microsoft is not getting off this bus.
Investment Case: The Single-Vendor Advantage
Now, if you put all these seemingly divergent products together – an operating system, a productivity suite of software applications, an enterprise management software application and a professional social network – what you get is a tapestry of products that serves various diverse purposes. And that gives Microsoft a tremendous advantage because it becomes the equivalent of a one-stop-shop for enterprise customers.
If all things were equal, would you rather walk into five or ten stores to buy ten items or buy ten products in a single store? To draw a retail analogy, that’s the difference between a specialty store and a supermarket. That is the strength that Microsoft has meticulously been going after with its many products, and you can now throw in a hardware division, Surface devices, along with its software offerings and what you have is the ideal single-vendor solution for nearly any type of business customer.
The only area where they are way behind the curve is on the Dynamics 365 front, but that segment also is showing signs of picking up speed. Moreover, now that the company is beginning to fully leverage LinkedIn’s massive user base, any growth in this segment will help complement the suite of software and hardware products that Microsoft now offers.
Microsoft is the only company that can cover the gamut of business users with products starting from hardware to operating system to cloud infrastructure to cloud-based productivity and collaboration software to enterprise-grade applications, not to mention the largest professional network in the world to help make the right connections. That’s a formidable breadth of offering, and this is where competition will come up short and will have to work in partnerships, such as Amazon working with Salesforce.com to take on Microsoft – a good indication that the sum of Microsoft’s product’s value is a little higher than their own.
And that’s the upside pushing Microsoft higher and higher as one product after another falls into place towards the master plan.