Microsoft Imprudence Outshined By Achievements

• The time has arrived to abandon mobile aspirations and focus on the cloud
• Company performing well at consumer and enterprise level with subscription services
• Revenues showing strong gains in spite of a revenue recession facing US corporations

Microsoft (MSFT:NASDAQ) was one of the clear tech winners in 2015. The company saw shares gain 18.0%, easily outperforming the market after several of its key divisions took off or continued their dominance. Sales of its Surface family products were stellar throughout the year, taking market share away from established competitors while its intelligent cloud and enterprise offerings continued to make important gains. However, the company has been stubborn in its insistence to enter the mobile phone market, despite repeated failures and miscues with rising costs continuing to offset gains made elsewhere. The company seems ready to try again with their newest “surface phones”, but would be better served by dedicating those resources elsewhere in order to maximize their revenue potential and see another year of remarkable returns.

Mobile Follies

The smartphone market has increasingly become a two horse race between Samsung and Apple with a bevy of other companies attempting to close the gap somehow. The market has become highly commoditized, and gains are hard to come by. In this market, Microsoft has been swimming upstream for the past three years with a variety of efforts that have at best proved unsuccessful, and at worst have been seriously harmful to the company’s bottom line.

To date, Windows phones have not been able to achieve any sort of significant penetration. Already at a serious disadvantage in 2014 with a pitiful 3.0% share of the market, Windows phones saw even further lows in 2015 with the company’s market share dropping to an almost insignificant 1.6% of operating system installs on mobile phones. Microsoft has made several different attempts to improve this current imbalance.

One of the company’s biggest moves in attempting to kick-start its moribund phone division was an almost $8.00 billion acquisition of phone maker Nokia (NOK) in 2014. Nokia, which had already partnered with Microsoft in producing several Windows phones, was presented by outgoing CEO Steve Ballmer as a way to ensure Microsoft’s place in the highly fragmented smartphone sector. A year later, however, the company has been forced to admit defeat once more and write off almost $7.6 billion as a loss, laying off over 7,500 employees, primarily in its phone division.

This would be bad enough, but rumors have Microsoft preparing a new mobile offering more closely tied to the highly successful Surface family of products. The new “Surface Phone” would be closer in design and function to the highly successful Surface Pro tablet/PC hybrids. At this juncture, it seems unlikely that Microsoft could have a big enough impact in the market to justify the costs associated with launching, producing, and marketing a new smartphone. Even the Surface brand will not be enough, especially after sales began to cool towards the end of 2015 aside from more competition sure to come. Overall, it would be more beneficial for Microsoft to admit defeat in the mobile sector, and refocus its efforts elsewhere.

Refocusing Efforts

The question then becomes, where should Microsoft re-channel its efforts and money? The clearest and best answer is to expand its efforts on its intelligent cloud and enterprise solutions. Microsoft has already shown that they are more than capable of providing comprehensive and effective solutions to compete with industry mainstays, and should continue to do so.

The company currently offers a variety of enterprise services that are profitable and continue to improve. In the third quarter of 2015, Microsoft’s Office 365 enterprise solution which is based on a subscription model has continued to show impressive gains, growing commercial revenues by nearly 70.0%. On the consumer side, Office 365 subscriptions jumped to 18.2 million, marking a ~3 million user gain for the quarter. Meanwhile, the company’s Dynamics CRM saw revenue gains of 12.0% for the same quarter, and installs grew by a factor of 3 year-over-year. The other major performer, the company’s Azure cloud infrastructure service showed impressive growth of over 130.0%.

Aside from revenue growth, the company’s enterprise services have been highly rated, and Azure especially has received stellar reviews in the industry. Despite the public acclaim and swiftly improving revenues, Microsoft’s Intelligent Cloud offerings are still facing stiff competition from established players such as Amazon Web Services and Google’s cloud services. Amazon has the advantage of working on razor-thin margins, and AWS has already proven a behemoth in the cloud computing segment.

Fundamentally Speaking

Microsoft remains a quintessential blue chip holding for almost any portfolio thanks to its continued success in delivering consistent shareholder value.  Last year’s returns easily outperformed both the S&P 500 and Nasdaq Composite in a sign of growing confidence among investors, especially considering the 7.2% revenue growth in fiscal 2015 at a time when most US corporations faced the onset of a revenue recession.  While some investors may view shares as overvalued based solely on the price-to-earnings multiple, the growth potential in the cloud combined with the brightening outlook for other key services merits this fair valuation.

In the meantime, share repurchases should help keep shares buoyed with the program set to last until the end of 2016.  Even with debt rising, cash on hand remains substantial at nearly $100.00 billion.  For value investors, further anticipated price appreciation combined with a 2.3% dividend yield should be enticing, especially for a stable company like Microsoft.  With dividend growth expected to continue, even a near-term correction lower towards $48.00-50.00 per share could easily give way towards $60.00-65.00 per share over the medium-term, overcoming dot com highs especially with the tailwinds of buybacks and strong underlying financials. 

Changing Gears

Instead of wasting money on a quixotic quest to break into a market where Samsung (SSNLF) and Apple (AAPL) have established a death grip, Microsoft should instead cut their already significant losses, and reinvest their energies into a sector that is increasingly looking like the major trend of the next decade. For the company to see shares rise above 52-week highs and continue its impressive run of restructuring and profit gains, their new year resolution should be to eliminate those sectors that are dead weight such as mobile in favor of those that could set the company up for the long-term like the cloud and enterprise. Should revenues continue to show strong growth, any near-term correction will not threaten the existing bullish trend that could potentially see shares hit a new record.