Microsoft Corporation (MSFT) released its fiscal third-quarter earnings Thursday after the close, and they were met with a chilly reception. Shares fell about 5% after hours.
The Street has been expecting earnings per share and revenues of 64 cents and $22.09 billion, respectively. Instead, they came in at 62 cents and $22.08, so it was close but no cigar for MSFT this quarter.
Reimagining MSFT Stock
Before we dig deeper into the numbers, a little context is necessary. Microsoft has managed to do something that is just about impossible for a mature technology company: It has redefined itself and moved in a very different competitive direction. Microsoft is no longer mainly a maker of PC operating systems and productivity software. It’s a cloud and business services company … or at least it is transitioning into one.
Sure, Apple Inc. (AAPL), Microsoft’s erstwhile rival in the PC era, managed to pull off a similar feat in the early 2000s. Apple transitioned from an also-ran in personal computing to a leader in digital music … and then did it again a few years later by evolving into the world’s premier smartphone company.
But turnarounds like these at large tech dinosaurs are definitely the exception and not the rule. With technology being as fast-changing and brutally competitive as it is, old giants tend to get felled.
Now, with that as background, let’s dig deeper into the numbers. Part of the miss can be attributed to Microsoft paying a higher average tax rate due to “a changing mix of revenues across geographies.” But overall, it was a case of strength in Microsoft’s cloud businesses simply not being strong enough to offset weakness in its old-line PC-based businesses … which calls into question the entire narrative about Microsoft reinventing itself.
Revenue in the Intelligent Cloud division, for example, grew only 3%. MSFT investors had been hoping for much higher growth out of that division.
Breaking down the numbers further, we do have some definite cause for optimism. Azure, Microsoft’s cloud development platform, saw its revenues jump 120% on a constant currency basis. So, the cloud is clearly getting traction.
Microsoft attributed the overall sluggish growth in that division to non-core cloud products like server software. But overall, investors seemed disappointed that strength in Azure didn’t translate to better results for the division as a whole.
Office 365 also continues to do well. The service now has 22.2 million subscribers, and revenue jumped 63% last quarter on a constant-currency basis.
Bottom Line for Microsoft
Overall, Microsoft had a decent quarter, and the company’s transition appears to be on track. Investors would have liked to have seen more, and PC-related products will continue to be a drag on performance for the foreseeable future. But you can’t turn a battleship like Microsoft on a dime. It will take time.
Looking at MSFT stock, there is still a lot to like here. MSFT stock trades at a forward price-to-earnings ratio of about 18, which is a little higher than the market average but still pretty reasonable by the standards of a high-margin tech company.
And Microsoft continues to prove its shareholder friendly bona fides by continually raising its dividend. Over the past five years, MSFT stock has hiked its dividend at a 19% annualized rate.
Investors might want to steer clear of Microsoft for the next couple weeks to allow for any post-earnings drift. But once the dust settles, they should consider MSFT stock as a solid long-term holding.
Five years from now, I wouldn’t at all be surprised to see Microsoft emerge as the leader in cloud services … even unseating current leader Amazon.com, Inc. (AMZN).
Charles Sizemore is the principal of Sizemore Capital, a wealth management firm in Dallas, Texas. As of this writing, he was long MSFT stock.
