Barclays Research analysts Raimo Lenschow and Chris Hogan believe Microsoft’s fundamentals are strong, and the lackluster response to their Q2 earnings give investors an opportunity to jump on board.


Microsoft Q2 earnings

Despite the organization being on the brink of considerable change with the pending appointment of the next CEO and the closing of the Nokia acquisition, Microsoft Corporation (NASDAQ:MSFT) delivered strong 2Q14 results. Total revenue came in at $24.52bn (+11% y/y) vs. consensus of $23.7bn, while EPS came in at $0.78 vs. consensus of $0.68. We believe these results reinforce our thesis laid out in our recent upgrade note, Refocusing on Fundamentals; Upgrading to OW, and would be buyers of the shares following the weakness to start 2014.

With recent comments from other PC ecosystem participants that the PC market was stabilizing, Windows was clearly in focus this quarter. The company stated that Windows OEM revenue declined only 3% (we were modeling for -8%) compared to industry-wide PC shipments being down ~7% in Q4. Additionally, Windows Non-Pro (consumer) declined 20% (we were modeling for -20%), while Windows Pro and volume licensing, the enterprise focused portions of Windows, grew a surprising +12% (we were modeling for +1%) and +10% (we were modeling for +5%), respectively. We believe these Windows results are better than investor expectations, although there were certainly be a focus on management’s outlook for Windows beyond the expiration of XP this spring, which could change things

Microsoft’s hardware and enterprise licensing businesses

Additionally, Microsoft Corporation (NASDAQ:MSFT)’s hardware (Surface and Xbox) and enterprise licensing businesses performed well in the quarter, in-line with our expectations, as detailed in our recent upgrade note Refocusing on Fundamentals; Upgrading to OW. Hardware revenue came in at $4.73bn (+68% y/y) vs. consensus of $4.0bn, while Commercial Licensing revenue came in at $10.9bn (+7% y/y) vs. consensus of $10.7bn, driven primarily by strong server product growth (+12% y/y vs. our expectation of +10%). Notably, Surface revenue was much stronger than expected at ~$893m (we were modeling for $640m), reinforcing our view that first party devices could start to fuel revenue upside.

Microsoft CEO search

Further, it appears the company has maintained strong momentum in its cloud businesses, as the Office 365 (commercial seat growth +127% vs. +135% in the prior quarter) and commercial cloud growth (+107% vs. +103% in the prior quarter) KPIs were both solid. We believe this momentum is critical as the ability of Microsoft Corporation (NASDAQ:MSFT) to be a major player in the cloud is a key tenant of the long-term investment case. On the conference call at 5:30pm ET investors will likely be looking for additional commentary around the progress/timing of the CEO search, but we do not expect too much detail here. We will also be waiting for management’s detailed Q3 guidance, as well as qualitative commentary around the state of the enterprise spending environment, which could be a catalyst for the entire enterprise software space tomorrow.

Figure 1: Summary of actual results vs. Barclays and consensus estimates

Barclays microsoft

Source: Company data, Barclays Research, StreetAccount