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Microsoft’s Secret Transition

Microsoft (MSFT) is supposedly doing a great job transitioning itself from a software provider, via CDs and installations on PCs, to a cloud company, with Office products being provided via the Internet. It’s also executing on its plan to be a major player in the hardware space via its Surface tablets.

The trouble is MSFT isn’t disclosing many of the pertinent figures I need to make a complete analysis. Here’s what the company provided in its last earnings release:

Devices and Consumer revenue grew 8% to $12.9 billion, with the following business highlights:
·Surface revenue of $1.1 billion, up 24%, driven by Surface Pro 3 and accessories
·Office 365 Home and Personal subscribers increased to over 9.2 million, up 30% sequentially over prior quarter
·Search advertising revenue grew 23%, with Bing U.S. market share at 19.7%, up 150 basis points over prior year
·Xbox console sales totaled 6.6 million units, with strong holiday season performance
·Phone Hardware revenue of $2.3 billion, with 10.5 million Lumia units sold driven by growth in affordable smartphones
·Windows OEM Pro revenue declined 13%; revenue was impacted by the business PC market and Pro mix returning to pre-Windows XP end of support levels and by new lower-priced licenses for devices sold to academic customers
·Windows OEM non-Pro revenue declined 13%, with license growth from opening price point devices

Commercial revenue grew 5% to $13.3 billion, with the following business highlights:
·Commercial cloud revenue grew 114% driven by Office 365, Azure and Dynamics CRM Online, and is now on an annualized revenue run rate of $5.5 billion
·Office Commercial products and services revenue declined 1%; transactional revenue was impacted by the continued transition to Office 365 and declines in commercial PCs following the XP refresh cycle
·Server products and services revenue grew 9%, with double-digit growth of SQL Server and System Center
·Windows volume licensing revenue increased by 3%, with annuity revenue growth partially offset by declining transactional revenue

What does that all mean? Lots of good things I suppose. But what I need to know is (A) how much business is MSFT losing in its old-school lines and (B) how much is being made up with the new products? It’s frustrating to read what the company did in units (like Xbox) without sales figures — and especially comparisons from last year.

One Year Chart

MSFT_2015_Q1And the reason I need complete figures is I have to guestimate what MSFT will make in the future, because obviously these numbers in the one-year chart don’t look good. Profits have been down, down, down and maybe they will rise 2QtrsOut but the company has been slashing profit estimates for more than a year so I doubt +18% profit growth is coming.

Also note MSFT hasn’t had a record year for profits since 2012. So this is a no-growth company with a lofty P/E of 17

Fair Value

MSFT_2015_Q1_FVI continue to think this stock is worth 12 times earnings and is extremely overvalued. This stock was $36 around a year ago and I think it could be $36 next year.

Sharek’s Take

I think Microsoft is on the right track, but I’m not amused with the lack of transparency. When I wrote my book The School of Hard Stocks around a decade ago I had MSFT ship me all its annual reports. When they arrived I was pleasantly surprised at how up front and simple the figures were — with profits up every year. Yes every year. Although this isn’t the same Microsoft I do feel management should be upfront with the business it’s doing and tell us about it. I can probably do a more thourough analysis and put the pieces together but that would be extremely time-consuming and a waste of my time since I probably won’t buy in anyway. At this point MSFT seems to be too high to buy, and although the new initiatives sound and look great I think we need to see more transparency before giving the stock another opportunity.

View the Earnings Table here.
View the Profit History here.
View the Ten Year Chart here.

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