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Why Microsoft Should Spinoff Its Cloud Business

Microsoft (NASDAQ:MSFT) currently features old-school solutions that are growing relatively slowly (Office and Windows) and new cloud solutions that are growing tremendously (Dynamics 365 and Azure). If the company stays in its current form, Microsoft stock will keep steadily advancing. But because the company’s total top and bottom lines are never going to increase much more than 30% or 35% per year, the shares are never going to deliver truly huge returns.

Why Microsoft Stock Would Benefit From a Spinoff of Azure
Source: Peteri / Shutterstock.com

But that would change if the company was to spin off its rapidly growing cloud businesses. In such a scenario, the current owners of Microsoft stock would receive shares in a cutting edge cloud services company (let’s call it “Azure”), and shares in a company focused on providing old, mostly PC-based software to businesses and consumers.

Azure’s stock is likely to get a forward price-earnings multiple that is at least as high as that of Salesforce’s (NYSE:CRM) 60, versus Microsoft’s current forward multiple of 29. And Azure’s stock could easily roughly quadruple in a year or two, as other tech hot-shots like Shopify (NYSE:SHOP) and Twilio (NASDAQ:TWLO) have in the past. Over a five-year period, a spun-off Azure could easily deliver the type of tremendous profits that Netflix (NASDAQ:NFLX) and Amazon (NASDAQ:AMZN) have in past years.

Meanwhile, the company focused on legacy software products, which could keep the Microsoft name, would still be extremely profitable. It would still generate meaningful growth and would retain some products, like Teams, GitHub, LinkedIn and Xbox. All of these are products that investors would still find at least somewhat exciting. Moreover, since it would still be very profitable and would not have to invest too much in R&D, relative to its free cash flow, it could pay a very high dividend, making it great for income investors.

Microsoft’s Braintrust Could Be More Focused

In the spinoff scenario, Microsoft’s current CEO, Satya Nadella, would be best-suited to become CEO of Azure. After all, under Nadella, Microsoft’s cloud revenue has soared tremendously, and its cloud infrastructure business has become the world’s second-largest, trailing only Amazon Web Services. Clearly, Nadella, who was previously executive vice president of Microsoft’s cloud computing business, knows what he’s doing when it comes to managing cloud ventures.

But I believe that Nadella and his top strategic and technical managers would do an even better job of growing the company’s emerging, high-growth cloud business if they could concentrate on that, rather than having to worry about many other businesses as well. For instance, under my scenario, Nadella and his top strategic and technical lieutenants could personally develop and supervise, on a day-to-day basis, Azure’s artificial intelligence (AI) strategy.

I doubt whether that’s possible currently. Similarly, I believe that Azure and Dynamics 365 could more quickly and efficiently adopt new technologies and move into new areas if they weren’t part of a huge tech conglomerate.

Overcoming Objections

When Nadella first became CEO, at a time when Azure was still a relatively nascent business, there were rumors that Microsoft would split itself into a consumer-facing company and a business-facing company.

It’s hard to see the rationale for such a split. As Nadella pointed out, many people use Windows and Office both at home and at their jobs, so it wouldn’t have made sense to split up the company’s sales, customer service and admin teams in that way. And, of course, there was not much difference between Windows and Office for consumers and the same apps for businesses.

But some skeptics, modifying Nadella’s 2014 call for the company to “go after [all] the users,” may object to the company losing its ability to cross-sell Windows, Office, Azure and Dynamics 365.

However, I don’t think that cross-selling ability necessarily has to disappear in the wake of a spinoff. To my knowledge, there’s no law or rule prohibiting the sales teams of Azure and Microsoft from sharing information on customers and cross-selling each other’s products, even though they technically would be working for two separate companies. I don’t even think there’s any law or rule prohibiting one person from heading the sales teams of both companies.

So I believe it would be entirely possible for the company to retain most or all of the advantages of being under one roof while also getting all the benefits of being separate.

The Bottom Line on Microsoft Stock

In its current form, Microsoft stock will keep steadily rising and generating admirable returns for its shareholders. But it will only be able to generate the types of returns that Amazon and Netflix have delivered in past years if it spins off its newer cloud businesses. Current shareholders or a new, activist investor should call for such a split.

As of this writing, Larry Ramer did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2020/02/microsoft-stock-benefit-cloud-business-spinoff/.

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