Microsoft Flexes Cloud Muscle, but Is It a Buy Today?

Bulls Say

• Public cloud is widely considered to be the future of enterprise computing. Microsoft’s Azure is a leading service that benefits from the evolution to hybrid environments and then ultimately to public cloud environments.
• A shift to subscriptions accelerates growth after the initial growth pressure. Microsoft has passed the margin inflection point now, and margins are increasing again, returning to pre-Nokia and pre-cloud levels.
• Microsoft has monopolylike positions in various areas like operating systems and Office that serve as cash cows to help drive Azure growth.

Bears Say

• Momentum is slowing in the shift to subscriptions, particularly in Office, which is generally considered a mature product.
• Microsoft lacks a meaningful mobile presence.
• Microsoft is not the top player in its key sources of growth, notably Azure and Dynamics.

Morningstar Analyst Dan Romanoff Says

Since taking over as CEO in 2014, Satya Nadella has reinvented Microsoft (MSFT) as a cloud leader. In our view, this company is one of two public cloud providers that can deliver a wide variety of platform-as-a-service and infrastructure-as-a-service solutions at scale. Additionally, Microsoft embraced the open-source movement and has largely transitioned from a traditional perpetual license model to a subscription model. Finally, Microsoft exited the low-growth, low-margin mobile handset business and is driving its gaming business to be more cloud-based. These factors have combined to drive a more focused company that offers Microsoft impressive revenue growth with high and expanding margins.

We believe that Azure is the centerpiece of the new Microsoft. Even though we estimate it is already an approximately $30 billion business, it grew at a staggering 50% rate in fiscal 2021. Azure has several distinct advantages, including that it offers customers a painless way to experiment and move select workloads to the cloud, creating seamless hybrid cloud environments. Because existing customers remain in the same Microsoft environment, applications and data are easily moved from on-premises to the cloud. Microsoft can also leverage its massive installed base of all its solutions as a touch point for an Azure move. In addition, Azure is an excellent launching point for secular trends in artificial intelligence, business intelligence, and Internet of Things, as it continues to launch new services centered on these broad themes.

Microsoft is shifting its traditional on-premises products to become cloud-based software-as-a-service solutions. Critical applications include LinkedIn, Office 365, and Dynamics 365, with these moves now beyond the halfway point and no longer a financial drag. Office 365 retains a virtual monopoly in office productivity software, which we do not expect to change in the foreseeable future. Microsoft is also pushing its gaming business increasingly toward recurring revenue and residing in the cloud. We believe that customers will continue to drive the transition from on-premises to cloud solutions, and we expect Microsoft's revenue growth will remain robust with margins continuing to improve for the next several years.

Key Proprietary Morningstar Metrics

Fair Value Estimate: $345
Star Rating: 3 Stars
Economic Moat Rating: Wide
Moat Trend Rating: Stable

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