One wouldn’t think that Microsoft Corporation (NASDAQ:MSFT) stock would be a beneficiary of the recent WannaCry ransomware attack. After all it was a Microsoft vulnerability that allowed hackers to execute the nefarious plot. MSFT stock might not be expected to fall on the news, given its size.
Indeed, Microsoft stock actually traded modestly positive on the Monday after the attack. But a worldwide, well-covered hack hardly seems like a benefit for MSFT.
Rather, one would think the gains would go to more traditional cybersecurity stocks. That was the case — albeit very briefly.
The PureFunds ISE Cyber Security ETF (NYSEARCA:HACK) opened up 4.2% on Monday after the weekend attack. Long-time laggard FireEye Inc (NASDAQ:FEYE) rose 7.5% in trading that day, while larger rival Palo Alto Networks Inc (NASDAQ:PANW) gained 2.7%. But as our Dana Blankenhorn accurately predicted, cybersecurity stocks have given back most, if not all of the gains from the news.
But the gains for MSFT stock should be less obvious and last longer. The question is whether it’s enough to support upside in Microsoft, a stock I’ve long thought was overvalued. Combined with other catalysts, the valuation for Microsoft stock might look a bit more palatable at the moment. I still believe, however, there are better plays in large-cap tech.
Why WannaCry Is a GOOD Thing for Microsoft Stock
Credit Suisse analyst Michael Nemeroff appears to be the first one to detail the hack-based bull case for MSFT stock. And that case makes some sense.
There has been some finger-pointing between Microsoft and the NSA — the reported source of the malware behind WannaCry — over how and when the required patch was released. But the patch was released ahead of time and, as Nemeroff points out, WannaCry only hit users running outdated versions of Windows. That includes XP and Windows Server 2003, for which Microsoft dropped support years ago.
For consumers, then, and more specifically for businesses, there’s a clear lesson from the attack. Users need to upgrade to Windows 10 to avoid potentially major security problems. Older versions are no longer “good enough”.
That creates a catalyst for upgrade demand and a potential catalyst for MSFT stock. Upgrades drive excellent incremental margins: It costs very little for Microsoft to ship a new copy of Windows 10. While consumer upgrades will help, the big money is on the business side. Nemeroff pointed out that some 85% of businesses haven’t yet moved to Windows 10. That creates a potential wave of upgrades for Windows 10. It also adds potential demand for cloud-based Office 365.
In other words, MSFT could see revenue improve, margins improve and closely watched cloud sales grow. That combination would do wonders for Microsoft stock.
Is WannaCry Enough for MSFT Stock?
The question is whether the opportunity is big enough to change the investment case for Microsoft stock. On that front, I remain modestly skeptical.
For all the optimism toward MSFT stock, earnings growth still remains incredibly meager. Adjusted EPS was $2.78 in fiscal 2012, and $2.79 in fiscal 2019. There’s room for improvement in the future, but Microsoft is moving away from where it’s dominant into markets where it is in second or third place at best. Xbox trails the Sony Corp (ADR) (NYSE:SNE) PlayStation. Azure is well behind Alphabet Inc (NASDAQ:GOOG, NASDAQ:GOOGL) and especially Amazon.com, Inc. (NASDAQ:AMZN) in cloud hosting.
There are some modest positive signs outside the core Windows and Office businesses. Azure might be in third place, but it’s growing quickly. The Surface line represents a real win in hardware, and finally a potential competitor to Apple Inc. (NASDAQ:AAPL) in that vertical. But Azure and Surface still drive less than 10% of total sales. They’re helpful, but not that helpful. The same seems to be true of any WannaCry-driven increase in Windows upgrades and Office conversions.
MSFT Stock Looks OK
With Microsoft stock trading at a little over 20x FY18 analyst consensus EPS estimates, there’s probably enough to support the current valuation around $67.
But it’s also tough to see MSFT stock as the best stock in the market — or even in large-cap tech. Facebook Inc (NASDAQ:FB) still looks cheap. Amazon’s dominance continues to expand. AAPL stock is cheaper on an earnings basis than MSFT stock, despite similarities between the long-term growth profiles of both companies (most notably a significant reliance on ‘core’ products).
WannaCry-driven upgrades could drive upside to sales and earnings over the coming quarters. But it takes a lot of upside to move the needle on a $520 billion stock. The ransomware attack should help Microsoft sales, and thus Microsoft stock. But I’m not sure it helps enough to turn bullish just yet.
As of this writing, Vince Martin has no positions in any securities mentioned.
