In-House Chip Development Is Exactly What Microsoft Stock Needs

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You can’t tell from the price chart but Microsoft (NASDAQ:MSFT) sent a shot across the bow that could have significant ramifications for years, perhaps decades to come. Bloomberg on Dec. 18 reported that the Software-as-a-Service giant plans to develop processors in house, reducing its reliance on third-party suppliers. While that caused a slight dip in Microsoft stock, it had significant consequences for others.

Image of corporate building with Microsoft (MSFT) logo above the entrance. tech stocks
Source: NYCStock / Shutterstock.com

Obviously, chipmaker Intel (NASDAQ:INTC) would be the biggest loser in that move. Sure enough, that day INTC shares dropped over 6%, ending what looked to be an encouraging rebound starting from the second half in November. Now, Intel faces severe scrutiny, not only for its technical weakness but for its fundamental viability moving forward.

True, INTC wasn’t the only one printing red ink. Again, Microsoft stock was slightly down, perhaps due to shareholder concerns about the initial cost outlays for building in-house processors via Arm Ltd.’s designs. They will be used for data centers to run Microsoft’s ever-expanding cloud-computing services. Rumors also suggest that management is exploring utilizing the chips to underline select computers from the Surface brand.

As Bloomberg reporters Ian King and Dina Bass wrote, “The move is a major commitment by Microsoft to supplying itself with the most important piece of the hardware it uses,” noting that rivals such as Amazon (NASDAQ:AMZN) have implemented similar initiatives. Primarily, tech firms have gone the independent approach because in-house “chips are better suited to some of their needs, bringing cost and performance advantages over off-the-shelf silicon primarily provided by Intel.”

For full disclosure, I’ve written about the possibility that INTC could offer a discounted buy for speculators. It seemed at the time that the bad news would eventually fade. As well, Intel’s Xeon server chips dominate internet and corporate networks, taking about 90% of market share despite heavy competition from Advanced Micro Devices (NASDAQ:AMD).

Now, the INTC narrative is much cloudier. But does this mean Microsoft stock is a screaming buy?

Probably the Best Decision for Microsoft Stock

Theoretically, it’s a better move economically to outsource chip production to third-party specialists. While the idea is that a company bringing such businesses in house will save costs, the reality is that semiconductor production is an extremely competitive business. In addition, the industry risks commoditization, a killer for tech firms.

This isn’t to say that if the in-house processor venture fails to deliver the goods, Microsoft stock will fail. But the underlying company was brought out of the weeds thanks to a combination of compelling products and services. For instance, I find it difficult to work on other non-Microsoft platforms. It’s this indelible nature that keeps MSFT safe from commoditization.

Still, if investors are worried about Microsoft stock regarding this processor plan, I’d set those aside. To take MSFT to the next level, this was perhaps the only strategy decision to make.

According to a Gartner survey, global spending on public cloud services is projected to hit $257.5 billion, representing 6% growth from 2019’s haul of $242.7 billion. Further, researchers see the public cloud spending jumping to $305 billion in 2021 and $362.3 billion, representing an average 18.6% growth year-over-year.

Microsoft cloud revenue vs. global cloud user spending
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Source: Chart by Josh Enomoto

At the same time, Microsoft’s cloud services segment has likewise been moving at a rapid clip. As a result, the company’s share of the global spending on public cloud services has increased dramatically. Between 2014 through 2016, MSFT’s market share on this global spend was 13%. From 2017 through (fiscal) 2020, market share increased to 17.5%.

More than likely, the cloud computing market will only grow in importance. Additionally, Microsoft should be able to take more of this market share. Therefore, to maximize its profitability potential, management decided to bring its data processor production in house.

While there will be some initial costs, in the long run, this is probably the best decision for Microsoft stock.

Did the Pandemic Push the Decision?

In an attempt to save Intel’s blushes, it’s possible that the novel coronavirus may have been one of the strongest contributors to Microsoft’s decision. True, cloud services were already booming and were universally expected to do so over the years ahead. But the pandemic made this issue that much more urgent.

According to accounting firm PwC, Covid-19 “has accelerated customer demand for cloud-based offerings,” with cloud spending increasing “37% to $29 billion during the first quarter of 2020.” Further, the company states:

This trend is likely to persist, as the exodus to virtual work underscores the urgency for scalable, secure, reliable, cost-effective off-premises technology services. In fact, despite the inevitable economic downturn in the wake of the pandemic, cloud spending is estimated to rise 19% for the full year, even as IT spending as a whole is forecast to fall 8%, according to industry analyst Gartner.

With the U.S. suffering worse than any other nation in terms of cases and deaths, circumstances indicate that cloud infrastructures will be more vital than previously imagined. MSFT’s management team is making the best decision for the new normal, which should be a source of comfort for stakeholders of Microsoft stock.

On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare. Tweet him at @EnomotoMedia.


Article printed from InvestorPlace Media, https://investorplace.com/2020/12/in-house-chip-development-perfect-for-microsoft-stock/.

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