Can Microsoft (NASDAQ:MSFT) do well in the middle of Covid-19? More importantly, what is the novel coronavirus pandemic doing to do Microsoft stock?
The first answer will become clearer when Microsoft reports its third-quarter results April 29 after the markets close. At that time, CEO Satya Nadella will update investors about how its business fared in the first three months of calendar 2020.
The New Normal
This time last year, Microsoft generated $30.6 billion in sales, 14% higher year-over-year, with an operating income of $10.3 billion, 25% higher than a year earlier. Given Covid-19, it’s going to be virtually impossible for the company to match or beat those results.
Barring a miracle, investors just want to make sure that its major money makers — Microsoft Azure and Office 365 — haven’t been hurt too badly from the global economic slowdown. Fortunately for businesses of all sizes, Microsoft’s products are indispensable for keeping their operations running.
Next to the face mask, the cloud could be the most important tool for fighting the coronavirus. CloudTech stated April 17:
Imagine the world without cloud computing. It may not collapse, but it will surely be mired by inefficiencies and a debilitating lack of options to go on with day-to-day living. The absence of cloud solutions would mean a long spell of boredom and inconvenience for many people. For businesses, it can result in interruptions in commercial activities without viable alternatives. The cloud has brought stability and flexibility for web-based platforms and services, so that they can continue working without getting overwhelmed by the sudden rise of people going online to do business, work, or play.
The cloud has become so indispensable, Alibaba (NYSE:BABA) just announced that it was spending $28 billion over the next three years on cloud infrastructure to make sure that it’s prepared for the next time a surge in cloud activity occurs. The investment is especially important for Alibaba because it’s trying to gain cloud market share outside China, where it controls almost 50% of the country’s cloud business.
As for Microsoft, InvestorPlace’s Dana Blankenhorn recently reminded readers that the company’s cloud business is growing faster than any other industry player, and that includes Amazon (NASDAQ:AMZN), the largest by global market share, at 40%.
Further, Blankenhorn stated, “much of Microsoft’s cloud revenue is in the highly-profitable area of Software as a Service, still just 23% of the total software market.”
Which is why it’s easy to see Microsoft stock getting to $200 or higher in the second half of the year once the economy and society have started to get back to some sort of normal, albeit something much different then we’re used to.
How Does Microsoft Stock Get to $200 and Beyond?
Wedbush Securities analysts Daniel Ives and Strecker Backe issued a research note April 20 that discussed the growth trajectory of the company’s cloud business. The analysts have an “outperform” rating on MSFT with a 12-month target price of $210, which represents 17% upside based on current prices.
“We have seen relatively strong cloud deal activity around Azure in the field, as this current remote work from home environment is further catalyzing more enterprises to make the strategic cloud shift with Microsoft the main beneficiary,” the analysts stated.
“The Street is focused on cloud growth heading into earnings, Office 365 success, and the Azure growth trajectory (we are expecting ~55% YoY) in this absolutely brutal uncertain COVID-19 sales environment.”
In Q3 2019, Microsoft’s Azure revenue grew by 75%, so the revenue increase this year will be smaller on a percentage basis, but larger in terms of the increase in dollars. That said, Microsoft doesn’t break out Azure’s numbers in its quarterly reports.
However, it did say in its Q3 2019 report that its commercial cloud revenue was $9.6 billion during the quarter. Azure is a significant of that along with Office 365 Commercial, the commercial portion of LinkedIn, Microsoft Dynamics 365, and other cloud properties. Some estimates put Azure’s quarterly revenue at $4 billion for a run rate of $20 billion, about half Amazon’s, which would seem to make sense since Microsoft is said to have 20% cloud market share compared to 40% for Amazon.
Based on the analysts’ 55% projection for Azure revenue growth in the third quarter, we’re looking at a run rate of almost $25 billion in 2020.
How does this translate to Microsoft’s stock?
“We are still looking at what we value as a $900 billion to $1 trillion valuation cloud franchise for Redmond [Microsoft HQ] off our more normalized FY21 revenue/EPS targets. We strongly believe even in a more stress-tested model that the risk/reward in MSFT is compelling at these levels,” Ives and Backe stated in their note to clients.
The Bottom Line
Microsoft stock is currently valued at $1.36 trillion. If we value its cloud business at $1 trillion, this means the rest of its business is worth $360 billion.
I don’t know about you, but I find that hard to believe. Perhaps that’s why InvestorPlace contributor Larry Ramer suggested in February that Microsoft spinoff Azure into its own independent company.
I don’t know if that would ever happen but I do think Microsoft’s stock has a good chance of trading above $200 later in 2020.
Microsoft stock is a buy.
Will Ashworth has written about investments full-time since 2008. Publications where he’s appeared include InvestorPlace, The Motley Fool Canada, Investopedia, Kiplinger, and several others in both the U.S. and Canada. He particularly enjoys creating model portfolios that stand the test of time. He lives in Halifax, Nova Scotia. At the time of this writing Will Ashworth did not hold a position in any of the aforementioned securities.
