Despite bygones, tech leaders and president elect Trump struck a friendly chord at this past Wednesday’s Tech Summit held at the Trump Tower in New York. However, gleaning potential policies from the topics discussed (and Trump’s campaign rhetoric) could spell trouble for several of the Tech Summit attendees, Microsoft in particular.
This article provides a brief review of Microsoft’s evolving business, several valuation metrics worth considering, and an overview of the potential impacts (positive and negative) of new policies that may come out of the Trump Administration such as those that would artificially create more US tech jobs, lower corporate tax rates, pressure interest rates higher, allow overseas cash repatriation, and utilize punitive tariffs with international trading partners.
Microsoft’s business consists of three segments: Productivity and Business Processes (consists of Office and Dynamics), Intelligent Cloud (consists of public, private and hybrid server products and cloud services, includes Azure), and More Personal Computing (consists of Windows, devices, gaming, search advertising, Bing and eventually LinkedIn). And for reference, the following charts show the revenue and operating margin breakdown and growth trajectory of each segment.
More Personal Computing is the biggest in terms of revenues, but has lower margins and is therefore the laggard in terms of operating income. And with regards to revenue growth, More Personal Computing (-1%) is also the laggard versus the other segments (+8% and +10%) on a year-over-year basis as shown in the following table.
With regards to Cloud, Microsoft seems to be the number two player (behind Amazon Web Services) in an extremely competitive space. Notwithstanding any mistakes, Cloud should provide Microsoft continued growth. Additionally, Microsoft’s Productivity and Business Process Application provide some strong advantages and barriers to entry versus peers, as does the Windows operating system.
For more perspective, the following graph shows how Microsoft’s Windows for PCs is becoming a smaller part of Microsoft’s revenue, and server products and tools are accelerating.
And from a bottom line standpoint, Microsoft’s net income remains healthy as revenues remain strong, as shown in the following chart.
Additionally, Microsoft has provided a positive outlook whereby revenue in two of its three segments is expected to grow (Productivity and Business Processes plus Intelligent Cloud, but not More Personal Computing).
From a price-to-earnings standpoint, Microsoft remains reasonably priced as shown in the following chart (taking the tech bubble era with a grain of salt).
Additionally, a basic discounted free cash flow model suggests Microsoft has some price appreciation potential. Specifically, if we discount Microsoft’s 2016 Free Cash Flow of $25 billion, by its 11.85% weighted average cost of capital and assume a 9.1% 5-year annual growth rate (this is the average estimate of the 8 professional analysts surveyed on Yahoo Finance), and a conservative 3-5% growth rate thereafter, then Microsoft is worth $465.0B to $580.4B after adjusting for outstanding long-term debt (-$60.2B) and cash and short-term investments (+$136.9B). On a per share basis, this amounts to a valuation between $59.76 and $74.61, which gives Microsoft current share price roughly 8% upside versus the midpoint of the range.
Worth noting, Microsoft pays a healthy dividend. The dividend yield currently sits at around 2.4% (as shown in the following chart) which is above average for Microsoft and above average for an S&P 500 company, particularly one in the technology sector.
In essence, Microsoft is a stable company with an above average dividend and the potential for more growth and share price appreciation.
New Administration Policies:
It is worth considering the potential policy changes (and their impact on Microsoft) that might come out of the Trump Administration following this past week’s “Tech Summit” (attended by Alphabet CEO Larry Page, Tesla and SpaceX CEO Elon Musk, Apple CEO Tim Cook, Facebook COO Sheryl Sandberg, Microsoft CEO Satya Nadella, Cisco CEO Chuck Robbins, IBM CEO Ginni Rometty, Intel CEO Brian Krzanich, Oracle CEO Safra Catz, and Amazon CEO Jeff Bezos, to name a few).
Specifically, we consider policies that may artificially create more US tech jobs, lower corporate tax rates, pressure interest rates higher, allow overseas cash repatriation, and utilize punative tariffs.
1. More US Jobs:
For starters, one of Trump’s biggest themes is US jobs creation. However, the types of jobs he’s talking about (middle class manufacturing jobs) aren’t going to help Microsoft, and his views on highly skilled international workers may actually harm Microsoft significantly. For example, Trump has been critical of H1B visas, claiming they take jobs away from Americans. In our view, H1B jobs help Microsoft attract the talent it needs to remain successful. For example…
“Microsoft is an outspoken opponent of the cap on H1B visas, which allow companies in the U.S. to