Global Equities

Stock story: Microsoft

The software giant in the Nadella era is strengthening its hold on the business world.

January 2019

Satya Nadella, 51, who joined Microsoft in 1992, was made the company’s third CEO in 2014, as co-founder and first CEO Bill Gates resigned as chairman. At the time, the software giant was criticised for missing out on the mobile revolution, and Microsoft’s share price had idled for more than a decade.

The Nadella era is so far proving to be one of the most dynamic in the history of Microsoft, especially in terms of its stock price. The company founded in 1975 recorded an adjusted net profit of US$30.3 billion in fiscal 2018, an increase of 18% on the previous year. This profit was built on sales of US$110.4 billion, 14% higher than a year earlier and 27% higher than in 2014. The share price of the company has tripled since 2014. On December 31 just gone, Microsoft was the world’s most valuable company.

Ironically for a company that is a household name and offers many consumer-targeted products such as Windows PCs, Xbox and its Bing search engine, Microsoft’s successes are built on its two business-oriented divisions, which have expanded sales at double-digit rates in recent years. One is the business-focused or ‘Productivity’ division, which generated 37% of Microsoft’s operating profits in fiscal 2018. The other is the ‘Intelligent Cloud’ division (including its rapidly growing Azure hyperscale public cloud), which pulled in 33% of operating profits in fiscal 2018. The segment aimed more at consumers is known as the ‘More Personal Computing’ division.

We estimate that 80% of Microsoft’s profits are sourced from businesses. The Windows PC operating system remains critical to business operations globally. Microsoft Office has a 90% market share on office ‘productivity’ software globally. Microsoft’s data-centre software products are deployed globally enabling ecosystems of third-party applications and further protected by the high cost and risk of switching to competing products. Microsoft is the second-largest vendor after Amazon Web Services in the rapidly growing public cloud market. Such holds on business are what make Microsoft a compelling long-term investment.

To be sure, much of Microsoft’s success in cloud and enterprise software is due to investments and decisions made in the era of CEO number two, Steve Ballmer (2000-2014). So all the credit can’t be attributed to the Nadella era (or Nadella). The sales growth of the More Personal Computing, which is still too large a market to overlook, has been more challenging as households have increasingly opted for smartphones and tablets over replacing their home PCs. The growth rate of the cloud and business software businesses is expected to slow over time.

But while the cloud and business software markets stay strong, Microsoft is investing to benefit. The 11% annual revenue growth across Microsoft’s Productivity and Intelligent Cloud segments over the past three years, as More Personal Computing sales shrank at a 0.9% annual rate, show how Microsoft is shifting away from its PC-centric beginnings. This profitable shift towards businesses will epitomise Microsoft’s Nadella era and, most likely, well beyond.

Steadier streams

Microsoft under Nadella, so far at least, is noticeable for how the company is more reliant on selling pay-for-use services that are often tied to multi-year contracts, rather than on product licences for software, where payment is upfront.

Other noticeable things Microsoft has done in the Nadella era are takeovers to acquire networks and intellectual capital. In 2016, Microsoft bought LinkedIn for US$26 billion. In a reversal on its pre-Nadella era stance against open-sourced software, in 2018 Microsoft paid US$7.8 billion for GitHub, an online code-sharing platform used by more than two million businesses and developers to write, store and share software. In 2014, Microsoft paid US$2.5 billion for Mojang, the publisher of the Minecraft video game, to bolster its gaming business. Other focuses have been spending discipline, ensuring privacy and cybersecurity, and exploring the opportunities presented by artificial intelligence and the internet of things.

Amid all these efforts, Microsoft is posting impressive results for an established tech company. For the first quarter of fiscal 2019, Microsoft posted a 19% jump in revenue to US$29.1 billion compared with a year earlier, as revenue from the Intelligent Cloud division surged 24% while sales from Azure soared 76%. Net income for the quarter jumped 34% to US$8.8 billion.

To the benefit of investors, the Nadella era is becoming synonymous for such double-digit earnings-per-share growth.

Sources: Company filings and website and Bloomberg.

Important Information: This material has been prepared by Magellan Asset Management Limited (‘Magellan’) for general information purposes and must not be construed as investment advice. This material does not constitute an offer or inducement to engage in an investment activity nor does it form part of any offer or invitation to purchase, sell or subscribe for in interests in any type of investment product or service. This material does not take into account your investment objectives, financial situation or particular needs. You should read and consider any relevant offer documentation applicable to any investment product or service and consider obtaining professional investment advice tailored to your specific circumstances before making any investment decision. This material and the information contained within it may not be reproduced or disclosed, in whole or in part, without the prior written consent of Magellan. Any trademarks, logos, and service marks contained herein may be the registered and unregistered trademarks of their respective owners. Nothing contained herein should be construed as granting by implication, or otherwise, any licence or right to use any trademark displayed without the written permission of the owner.

Statements contained in this material that are not historical facts are based on current expectations, estimates, projections, opinions and beliefs of Magellan. Such statements involve known and unknown risks, uncertainties and other factors, and undue reliance should not be placed thereon. Additionally, this material may contain “forward-looking statements”. Actual events or results or the actual performance of a Magellan financial product or service may differ materially from those reflected or contemplated in such forward-looking statements.

Certain economic, market or company information contained herein has been obtained from published sources prepared by third parties. While such sources are believed to be reliable, neither Magellan or any of its respective officers or employees assumes any responsibility for the accuracy or completeness of such information. No person, including Magellan, has any responsibility to update any of the information provided in this material. 

How to invest

  • Magellan offers two market-leading strategies, global equities and global listed infrastructure. Find out how easy it is to invest in the world’s best companies, as chosen by Magellan’s experts.

  • Global equity products

    You buy from the world’s best companies, so why not invest in them? Magellan offers a range of highly-rated global equity funds, containing some the world’s best companies that we believe are positioned to benefit from long-term investment tailwinds.

    Find out why investing in a diversified global fund makes sense.

    Invest in global equities
  • Global listed Infrastructure products

    Infrastructure: Supporting you every minute of every day. Our range of top-rated global listed infrastructure funds are positioned to generate inflation-protected, stable yet solid returns.

    Discover why including listed infrastructure in a diversified portfolio can enhance returns and reduce portfolio risk.

    Invest in global infrastructure