Valuation, Growth and Profitability
Our fair value estimate for Microsoft is $32 per share.
We have extended our explicit forecast for Microsoft out to 2019 to incorporate the decline of Windows and Office, as
well as the growth of Windows Azure. We expect compound annual revenue growth of 1.9% over the next decade. Given the cloud disruption, Windows and Office will be empty shells by 2019 and contribute immaterial amounts to revenue by 2019.
The vast majority of Microsoft’s revenue will come from Azure, which we
believe will be a very profitable business. The very high technical and financial barriers
to entry to building a cloud, along with the massive returns to
scale, point to an industry with a handful of very large players.
While some cost savings will be shared with customers, we expect a significant portion of the economic profit to flow to the cloud providers.
The threat to Microsoft’s core businesses of Windows and Office posed by cloud computing is the dominant risk.
Google is a capable competitor that is intent on disrupting Microsoft’s cash cows to restrict Microsoft’s ability to disrupt Google’s cash cow in Internet search. Regulatory and antitrust issues are also an issue.
The release of Windows 7 should entice many enterprises and
customers who skipped Windows Vista to finally upgrade from Windows XP.
With a war chest of cash and an AAA debt rating,
Microsoft is one of the few firms with the technical and
financial resources to invest heavily in cloud computing.
Windows Azure enjoys many inherited advantages such
as Microsoft’s existing base of third-party Windows developers.
The Bing search engine is Microsoft’s most viable effort in
Internet search thus far, and its partnership with Yahoo gives both
companies their best chance to chip away at Google’s dominance.
Cloud computing is a disruptive force, and Microsoft may be
handicapped from competing fully by the need to protect its legacy
The growth of netbooks and emerging markets will
pressure the selling prices of Windows. Piracy is also a
larger problem in emerging markets.
Although Microsoft has settled a majority of its
antitrust issues, the firm will continue to operate under
a regulatory microscope. Such regulatory oversight may
make it difficult for Microsoft to raise prices or further its market share dominance.
Financial Health: Even after buying back $60 billion of
stock during the last five years, Microsoft’s fortresslike balance sheet still
boasts $40 billion of cash and long-term investments against only
$39 billion in total liabilities.