Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?

Key Takeaways:

  • Microsoft needs little introduction, it is the second biggest company by market-cap in the world and has been one of the leading harbingers of the information age. It has several advantages vs other FAANG.
  • Microsoft qualifies for more themes in our  Granny Shots portfolio than any other stock. It qualifies for all three of our strategic themes: the economic rise of millennials, the rise  of AI/Automation and a high-asset intensity in a reflationary environment.
  • The company has been and will continue to be one of the main beneficiaries of the acceleration of the digital transformation caused by the pandemic.
  • The company has been repeatedly beating consensus growth estimates and the scale, size and scope of its balance sheet means it has multiple paths to growth including through acquisitions.
  • There are dark anti-trust clouds on the horizon for the newer members of Tech, but even Apple is experiencing anti-trust woes over its Ap-store behavior. Microsoft is insulated from the wrath of the US government and is increasingly one of its most important partners in cyber-security.

Microsoft ( MSFT -0.33% ) needs very little introduction given that many of us have been using its products for much of our lives. The Sultan of Software and the emperor of personal computing, Microsoft truly is a sprawling empire. Its Microsoft Office Suite has probably been a pretty crucial tool for anyone who has spent a lot of the time in the office over the past decades. Despite missing the boat on social media and smart-phones, the company has outwitted irrelevance by becoming one of the most versatile in capable players in the ever-important world of cloud computing. Revenue from Intelligent Cloud is now the company’s largest segment.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?
Source: Trefis/Thinkorswim

The company has been on a roll lately and like many of its large-cap technology peers the sheer prodigiousness of the company and the incessant need for its main products made it a safe-haven during the initial phase of post-pandemic investing. We think recent weakness in the name around rates should present an opportunity because the company has an unshakeable foundation with ample future paths to continued-high growth.

The company has proved remarkably competent at creating one of the stickiest products in modern history, the Microsoft Office Suite. The sales associated with this product have been given new life as work-from-home came to dominate the thrust of enterprise IT sales in the wake of the pandemic. Microsoft Office has the highest penetration in the productivity market. So what, the company has great software? Everyone knows that.

Cloud With A Scoop of Metaverse

The thing is that its strength here feeds into Azure and the cloud and the ubiquity of its product makes it easier to cross-sell products. Microsoft has a virtuous eco-system that enables it to be quite creative when it looks for merger partners, a major advantage when you’ve got over a hundred billion lying around. The old inflexible and combative Microsoft is a thing of the past as well. Whereas, the last CEO called open-source software a “cancer,” Satya Nadella has reigned over creating a cash-cow that eclipsed the company’s software dominance. Azure now hosts more accounts using Linux than Windows.

The cloud revenue that Google, Amazon and Microsoft derive should have continued support from the continued adoption of virtual reality and augmented reality. The functions and uses here should be exponentially increased by the metaverse. So, again you have secular forces supporting revenue, but Microsoft also has a leading product to help steer customers to its eco-system. This is where they have a major advantage, and growth has been consistently above consensus estimates in the past quarters. This is part of the reason we think that has occurred.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?

Though the company certainly benefitted from COVID-19 specific tailwinds, some of which may temper, it is still one of the undisputed commercial juggernauts of planet earth and we see a few reasons why we think it is a better place to put your hard-earned funds than some of the other FAANG names. The company has been consistently gaining market-share in cloud against Amazon’s AWS and cyber-security concerns are leading to a flurry of upgrades in the Productivity and Business Processes segment.

Microsoft has quietly been innovating and learned lessons from its brash earlier days where it clashed with the US Justice Department over anti-competitive practices. It has learned that it is better to be friends with Uncle Sam rather than antagonize him and it is therefore looking at decidedly bluer skies than the likes of Amazon, Meta, Google and Apple in the area. It has also managed to avoid drawing the social ire associated with some of these other company’s products and their affects on the human psyche. It is a juggernaut that is winning in many areas and is effectively investing in the competitions that will define the markets of tomorrow, like quantum computing.

Hey, You, Get Off of My Cloud!

The importance of cloud computing was something that was certainly augmented by the dreadful pandemic we have been enduring. Most businesses would not have been able to continue operating without it. It is a good exercise to think about what would have happened to the global economy in a world where computing power was not significantly leveraged by cloud computing. While Amazon’s AWS remains the undisputed leader Microsoft’s Azure and cloud capabilities are definitely number two with a bullet. As you can see below, Microsoft has about a third as much business as AWS and about three times as much as Google.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?
Source: IDC, Bloomberg Intelligence

Cloud computing as a solution has become one of the most important areas for enterprises across all sectors and industries, however, for highly regulated industries like healthcare and finance it is usually impossible or difficult to go to a fully public-cloud solution. For these companies, the more sophisticated solution of hybrid cloud is necessary and we believe Microsoft has a clear advantage here over its chief competitors. This is also an area where being a legacy-technology name with a huge relationship network can come into handy, most enterprises are very comfortable with Microsoft as a commercial partner.

The company has a sprawling network of products that help commercial enterprises all across the world leverage the power of computing and software. A nuts to nuts comparison between AWS and Azure is difficult to conduct because of differences in how both companies report revenue in the segments, but one thing is clear: over the past years, Azure has been growing faster.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?

Age Before Beauty

There is a lot of talk about some of the new-fangled members of the FAANG cadre but on a 5-year basis Microsoft and Apple are still showing the rest of the gang how to properly deliver to shareholders. While some FAANGs may be facing the existential threat of new anti-trust legislation that redefines the legality of business models in the digital age, Microsoft has become the cyber-security maven of the US government and Western World. In the old days, Microsoft’s behavior was more akin to the naughtiness and pushiness that Apple has been displaying with commercial partners.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?
Source: SeekingAlpha.com

Today, many enterprises seem to prefer the elder of the Seattle scions (Azure is growing revenue faster than AWS). It is a decidedly responsible corporate citizen compared to its peers which means it is insulated from the one major risk the rest of the FAANG stocks share. If you don’t think government policy can dramatically effect share price just look across the Pacific. Some of the current pieces of proposed legislation in the United States go way further at eroding competitive advantage of big-tech business models then even the Chinese Communist Party went. Having big gone through their period of scrutiny will likely be a big advantage going forward.

The company’s established infrastructure is feeding into its growth initiatives. It is a leader in cyber-security and it is a key partner of the US government instead of an adversary to it. This can pay off and  is more likely to when Uncle Sam is entering a generational great-power contest with the Communist Chinese. One of the key emerging areas of that competition is also a key areas where Microsoft is investing to bolster its moat and continue its impressive strides.

Will Microsoft Make The Quantum Leap?

Quantum computing holds great potential to be one of the most significant technological breakthroughs in history. Whereas classical computers have greatly evolved in function and efficiency, they are limited by using only 1’s and 0’s. We are steadily approaching the physical limits to Moore’s Law and if the computing revolution is to continue, many think it will be done with quantum computing.

Quantum computers use the insights gathered from the cutting edge of physics and may eventually be able to outperform any classical computers. While many obstacles remain to quantum supremacy, or the time when they will be able to consistently outperform classical computers, the interest and level of investment has been steadily increasing.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?

Microsoft has made a major acquisition in the area with PsiQuantum. The company is investing big in the area of quantum computing and its extensive product offerings and copious amounts of data mean that it could very well derive benefit from the cutting-edge technology. However, a company that was once known as the epitome of a “walled garden” is actually leading the quest to make to quantum computing not only democratized, but useful for the enterprises from which it derives the majority of its revenue. It is partnering with everyone it can to ensure it provides the best experience available to its enterprise customers.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?
Source: CBInsights

Microsoft has certainly faced some setbacks in its desire to build leading quantum hardware, even though it has been at the vanguard of making quantum computing usable through the cloud. Microsoft seems to be assessing different paths to quantum hardware and though PsiQuantum’s method is certainly not proven the best at this point, if it does turn out to be effective Microsoft will likely be able to scale up far quicker than peers. Despite Google being in the headlines for somewhat dubious claims around quantum computing, Microsoft holds more patents in the area than anyone except for Big Blue.

Microsoft ($MSFT:$313.88): What’s At The Top Of The Cloud?
Source: CBInsights.com

Risks And Where We Could Be Wrong

Well, we spent some time highlighting why we thought Microsoft was insulated from some of the anti-trust risks that its younger peers may be subjected to, there are still other FAANG characteristics the stock cannot escape. Microsoft is a staple in growth portfolios across the world and like other FAANG it is a high duration asset, or has a high P/E ratio. When rates go up, like in the aftermath of hawkish Fed minutes, then these stocks become relatively less attractive. The risk/adjusted returns of the bonds they are acting as proxies for gets better when the yield goes up.

So, we realize there are some headwinds for this name. If those headwinds converge with slowing growth or missed expectations, then you can expect some nasty price action. Remember though, three of the four thematic portfolios that resulted in the stock being picked for the Granny Shots Portfolio have an expected three-to-five-year time horizon to have their implications fully realized.

There is a risk that consensus or management has not properly calibrated actions and investments to be timed with when the extraordinary tail winds for COVID in areas like Productivity and Personal Computing. You can see what happens to a high P/E technology name when growth expectations are rapidly changed, or management is caught flat-footed with what happened to DocuSign last quarter. Microsoft is leaps and bounds ahead of those guys in execution though and the recent run-up of the stock likely will have attracted some top talent, always an important consideration for large technology firms. The culture gets high marks these days.

Microsoft is involved in many different product thrusts and competition with the big guys and with start-ups is always a consideration for a technology company. Microsoft has one of the most intractable holds on a market of any company around and we don’t think this will change anytime soon. We think their considerable and leading-edge efforts in quantum computing should give the readers the sense that they are approaching competitive threats effectively.

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