MKM Partners Managing Director Israel Hernandez maintains a Neutral rating for Microsoft Corporation (NASDAQ:MSFT) as the tech giant appears set to appoint Satya Nadella as its CEO, replacing Steve Ballmer.

Satya Nadella Microsoft

After a prolonged search, Microsoft Corporation (NASDAQ:MSFT) appears set to appoint Satya Nadella, EVP of its Cloud & Enterprise Group as its next CEO to replace Steve Ballmer. In addition, reports indicate that founder and current chairman Bill Gates will cede the chairman role to independent director John Thompson but will remain as a board member. As of last night, neither of these reports have been confirmed by Microsoft.

Microsoft goes with the safe internal pick

After being unable to attract or find an outsider to execute change, Microsoft Corporation (NASDAQ:MSFT), in our view, went with the safe pick, one with both established technology credentials and success running large parts of its enterprise business. Mr. Nadella, 46, is the longest tenured Microsoft exec considered for the CEO role, having joined the company in 1992. He is a corporate insider who has held leadership roles across a number of Microsoft businesses including Online Services, Microsoft Business Division (Office) and Server & Tools. Most recently, as EVP of Cloud & Enterprise, he has been spearheading Microsoft’s transition to a cloud & services company. His core areas of focus include Azure, Windows Server, SQL Server, Visual Studio and Systems Center, collectively branded as ‘Cloud OS’, Microsoft’s next generation back-end platform.

Activist camp likely to be disappointed with internal hire

In our view, the selection of Mr. Nadella, will be viewed by some investors hoping for an outside change agent to implement for shareholder friendly initiatives (cost cutting, financial engineering, etc.), as a disappointment but the news is not likely to come as a surprise given well-publicized leaks over the past couple weeks. Our initial thought is that Mr. Nadella is unlikely to deviate too significantly from Microsoft Corporation (NASDAQ:MSFT)’s recent corporate strategy shift to a devices and services company. This would imply that the much-maligned consumer segments (Bing, xBox, Surface, Nokia) are likely to remain core components of the business going forward. Mr. Nadella has also recently commented in the press that Microsoft’s share of IT remains small – “We have a significant commercial business but in the big scheme of things, when you say 2 trillion dollars, we’re nothing ($45 billion).” The shift to cloud infrastructure (Azure) and services will be the key component of tapping into this opportunity, but it may also imply a more aggressive stance on M&A, which Microsoft has historically shied away from. We believe the hiring of an insider is also likely to have a positive impact on employee morale as an external hire would likely have contributed to a significant change in the corporate culture.

From a stock perspective, we view Mr. Nadella’s hiring as likely already priced in so we do not expect a major move in the stock in either direction. The chief concerns will be Mr. Nadella’s experience (this is his first CEO job); his ability to truly exercise change (will he break with Gates/ Ballmer strategy), his ability to anticipate radical technology shifts (especially in the consumer market); and willingness to make difficult decisions to appease shareholder concerns (status of xBox, Bing and other low margin initiatives). We believe investors will view the potential stepping aside of Mr. Gates as chairman as an incremental positive, as some have viewed him (as well as Mr. Ballmer) as impediments to major structural change.

Our rating for Microsoft Corporation (NASDAQ:MSFT) remains Neutral with a fair value estimate of $35.