MICROSOFT CORP. $40 (Nasdaq symbol MSFT; Aggressive Growth Portfolio, Manufacturing & Industry sector; Shares outstanding: 8.3 billion; Market cap: $332.0 billion; Price-to-sales ratio: 4.1; Dividend yield: 2.8%; TSINetwork Rating: Above Average; www.microsoft.com) is the world’s largest software company. It went into business in 1975 and grew rapidly over the next 25 years as its Windows operating system dominated the personal computer market. About 90% of the world’s computers now use the Windows operating system.
In the late 1980s, the company launched its Office suite of business programs, including a word processor (Word), spreadsheets (Excel) and slide presentations (PowerPoint). Office accounts for over 90% of this market.
Microsoft also controls about 75% of the market for software that runs corporate network servers. That helps support sales of Windows and Office, because businesses prefer to have their servers and employees’ computers running the same software. This compatibility makes it easier for users to upgrade their software and protect sensitive data.
The company’s revenue rose 33.2%, from $58.4 billion in 2009 to $77.8 billion in 2013 (fiscal years end June 30).
Earnings jumped 59.0%, from $14.6 billion in 2009 to $23.2 billion in 2012. Due to fewer shares outstanding, earnings per share rose 67.9%, from $1.62 to $2.72. However, European regulators fined Microsoft $733 million for using its market dominance to make it harder for users of new computers to install other firms’web browsers. That’s the main reason why its earnings fell to $2.65 a share (or a total of $22.5 billion) in 2013.
To cut is reliance on Windows and Office, Microsoft has acquired or released new products in related areas. These include its Xbox video game console, Bing Internet search engine, Skype video calling service and Surface tablet computer.
Nokia deal key to mobile growth
The company recently completed its $7.2-billion purchase of Nokia’s smartphone operations.
This business faces intense competition from Apple’s iPhone, and devices powered by Google’s Android software. However, Nokia is the only major phone maker that uses Microsoft’s Windows Phone software. Microsoft believes this purchase will help it sell more of its phones, and encourage other software makers to write more programs, or apps, for the Windows Phone platform.
A court recently ruled that Google’s software violates some of Microsoft’s mobile patents. The company has since signed new licensing deals with several leading Android phone makers. While the terms are confidential, Microsoft probably earns $5 on each Android device sold.
The company also aims to fuel its growth by adapting more of its software to run on non-Microsoft devices. In April 2014, it launched a new Office app for Apple’s iPad. So far, over 27 million users have downloaded the app.
Microsoft feels that a big part of its growth will come from cloud computing, where data is kept on centralized servers that users connect to over the Internet. As a result, the company is shifting away from selling software as a one-time purchase, and instead selling it as a subscription. In the long term, that should provide it with higher revenues.
Cloud-based Office 365 looks like a hit
In 2011 Microsoft launched Office 365, which lets users create, edit and store their documents on the company’s servers. This service now has 4.4 million users and generates $2.5 billion of annual revenue.
The company is also seeing strong demand for its Azure cloud service, which helps businesses set up their websites and databases. Azure is growing because it’s cheaper for users to set up and run than building data centres from scratch.
Microsoft’s strong balance sheet will let it keep investing in new growth projects (it spends 13% of its revenue on research) and making acquisitions. As of March 31, 2014, it held cash and investments of $88.4 billion, or $10.71 a share. Its long-term debt of $20.7 billion is a low 6% of its market cap.
The company is also using its high cash balance to repurchase more shares. In October 2013, it authorized a new $40-billion buyback plan. There are no time limits for these purchases. As of March 31, 2014, it could still buy back $36.2 billion worth of stock.
In addition, Microsoft still has plenty of room to keep raising its dividend. The current annual rate of $1.12 a share yields 2.8%.
Integrating the new Nokia operations will limit the company’s fiscal 2014 earnings to $2.69 a share, and the stock trades at 14.9 times that estimate. That’s a low p/e ratio in light of Microsoft’s dominant market share, high research spending and improving outlook.
Spinoff potential adds appeal
The company could unlock some of its value by selling or spinning off its less-profitable businesses, such as Xbox, Bing and Surface. Microsoft would probably sign software-licensing deals with these independent companies, which would still let it profit from their future growth.
Microsoft is a buy.
