"Exploring Microsoft: An In-Depth Equity Research Analysis"

Equity Research Report                                              

About the Company

·       Origins and Growth: Founded in 1975 by Bill Gates and Paul Allen, Microsoft originated as a small software company. Over the decades, it has grown into a global technology giant, leading in operating systems, productivity software, cloud services, and diverse innovations.

·       Global presence: Microsoft boasts a formidable global presence, with offices, data centers, and operations spanning over 190 countries.

·       Commitment to innovation: Microsoft maintains an unwavering commitment to innovation, investing in cutting-edge technologies such as artificial intelligence, cloud computing, and mixed reality.

·       Global workforce: Microsoft employs a diverse global workforce of over 180,000 employees, contributing to its innovation and leadership in the tech industry.

·       Digital convenience: Microsoft provides digital convenience through its integrated ecosystem, offering seamless connectivity and productivity across devices, cloud services, and collaborative tools.

·       Key features: Microsoft is recognized for its comprehensive suite of products and services, including the ubiquitous Windows operating system, productivity tools like Microsoft Office, robust cloud platform Azure, and innovative hardware such as the Surface devices.

·       Sustainability focus: Microsoft is committed to achieving carbon negativity by 2030 and removing all historical carbon emissions by 2050, aligning its sustainability efforts with ambitious environmental goals.

Concalls Highlights

1.       Revenue Performance

The company's revenue has seen steady growth, climbing from

$125.8 billion in 2019 to $211.9 billion in 2023. Notably, there were substantial 18% increases in both 2021 and 2022, but the growth rate moderated to 7% in 2023. This data reflects a generally positive revenue trend, with a slight deceleration in the most recent year, indicating potential shifts in market dynamics or internal factors influencing the growth trajectory.

2.     Earnings and Growth Projections

Over the last five years, the company's diluted earnings per share (EPS) has displayed a positive trajectory. Starting at $5.06 in 2019, it rose to $9.56 in 2023. The growth rates varied, with a notable 40% surge in 2021 and a subsequent 20% increase in 2022. However, there was a slight decline of 1% in 2023. Despite the dip, the overall trend indicates robust earnings growth. The fluctuations suggest potential external factors impacting profitability, warranting a closer examination of the company's financial strategies and market dynamics during the observed period.

3.     Operating Margin and Earnings Growth

Over the five years, the company's EBITDA has demonstrated consistent growth, increasing from $54.6 billion in 2019 to $103.6 billion in 2023. The EBITDA margin also showed improvement, rising from 43% in 2019 to a stable 49% from 2021 to 2023. This indicates effective cost management and operational efficiency. The sustained high EBITDA margin suggests the company's ability to generate substantial earnings relative to revenue. Overall, the data reflects a financially sound operation with a focus on optimizing profitability and maintaining a healthy margin over the observed years.

4.      Strong Balance sheet and Cash flow

As of September 30, 2023, Microsoft's balance sheet reveals strong financial health. Current assets, including cash, investments, and receivables, reached $207.59 billion, ensuring liquidity. Property, plant, and equipment (PPE) and long-term investments totaled $141.54 billion, highlighting sustained growth efforts. Liabilities, comprising short-term and long-term obligations, stood at $225.07 billion, manageable against assets. Shareholders' equity amounted to $220.71 billion, reflecting robust financial standing. Microsoft's strategic balance between assets, liabilities, and equity positions the company favorably for future endeavors, emphasizing stability and growth.

Business Segments

·       Server and Cloud Services Momentum: Impressively growing at a steady pace, Server products and cloud services experienced a substantial increase in revenue, with a growth rate reaching its peak at 145% in 2023 compared to the baseline in 2019.

·       Office Products Expansion: Office products and cloud services maintained robust growth, showcasing a consistent upward trajectory, reaching an impressive growth rate of 52% in 2023 compared to 2019.

·       Gaming Sector Dynamics: The gaming sector demonstrated resilience and growth, peaking at a growth rate of 43% in 2022, followed by a slight dip to 35% in 2023, possibly influenced by market dynamics or specific product cycles.

·       LinkedIn and Search Advertising Impact: LinkedIn and Search and News Advertising sectors displayed solid growth, reflecting Microsoft's success across diverse segments, with growth rates maintaining an upward trend.

Competitive positioning

The provided data offers insights into the market share distribution within a specific industry, showcasing the dominance of key tech companies. Microsoft emerges as the industry leader, commanding an impressive 39.31% market share. Following closely is Oracle with a substantial 17.58%, positioning it as a significant player in the market. SAP SE secures the third position with a 6.23% share, contributing to the competitive landscape. Salesforce, Block Inc, and Adobe Inc also command notable shares, signifying their strong presence and impact. Microsoft's commanding lead, more than double that of Oracle, underscores its influential position within the industry. The cumulative market share of the top ten companies stands at 83.73%, indicating a market heavily concentrated among major players. This concentration suggests that the industry is shaped by a handful of key corporations, with Microsoft, Oracle, and SAP SE playing pivotal roles. However, the data also sheds light on a diverse range of players beyond the top contenders. Intuit Inc, NetEase

Inc, Activision Blizzard, ServiceNow Inc, and others collectively represent the remaining 15.46% of the market. This highlights the presence of a variety of players, each contributing to the industry's overall dynamism

Q1’2024 Earning Release Highlights

§  Product Performance & Outlook

·       Microsoft Cloud Performance: Quarterly revenue for Microsoft Cloud surpassed $31.8 billion, marking a 24% increase. Azure continues to gain market share, with more than 60 data center regions globally.

·       AI Integration: Microsoft is infusing AI across its tech stack, making the age of AI real for users. AI services are deployed globally, with a focus on training and inference capabilities. More than 18,000 organizations use Azure Open AI services.

·       GitHub Copilot: The introduction of GitHub Copilot has significantly increased developer productivity by up to 55%. Over 1 million paid Copilot users and 37,000 organizations subscribed to Copilot for business, with a 40% increase quarter- over-quarter.

·       Power Platform and Dynamics 365: Copilot has been extended to Power Platform, enabling natural language app creation. Dynamics 365 continues to gain market share, emphasizing AI- led business process transformation.

·       Healthcare Solutions: Microsoft's Dragon Ambient experience solution in healthcare has been used in over 10 million interactions. AI models like DAX Copilot are helping streamline clinical note documentation and reduce physician burnout.

·       Future of Work with Copilot: Copilot serves as an everyday AI assistant, enhancing creativity, analysis, expressiveness, productivity, and collaboration in Microsoft 365 applications. Teams usage continues to grow with over 320 million monthly active users.

·       Windows Innovations: Windows 11 has received a major update with 150 new features, including AI-powered experiences in apps. Windows 365 Boot and Switch facilitate personalized Cloud PC deployment.

·       Security Solutions: Security Copilot, an advanced generative AI product, is integrated with Microsoft 365 Defender to address the increasing sophistication of cyber-attacks. Microsoft Sentinel has surpassed 25,000 customers and a $1 billion annual run rate.

·       LinkedIn Growth: AI-driven features are transforming how LinkedIn's 985 million members learn, sell, and get hired. Record engagement includes 450 million newsletter subscriptions globally, a 3x YoY increase.

·       Search, Advertising, and News: Bing and Microsoft Edge have gained market share for 10 consecutive quarters. Copilot for the Web is redefining internet usage, and AI integration in ad platforms improves connection with customer intent.

·       Gaming and Activision Blizzard King Acquisition: Microsoft's acquisition of Activision Blizzard King aims to bring great games to players everywhere. Game Pass sets records in hours played per subscriber, and new titles, including Call of Duty: Modern Warfare 3 and Forza Motorsport, are anticipated.

§  Financial Metrics

·       Financial Performance:

Revenue: The quarter's revenue reached $56.5 billion, a 13% increase (12% in constant currency). Earnings Per Share (EPS): $2.99, a 27% increase (26% in constant currency).

·       Commercial Business:

Renewals in Microsoft 365 E5 were robust. New business growth moderated for standalone products outside the Microsoft 365 suite. Azure optimization trends were in line with expectations.

·       Consumer Business:

PC market volumes are returning to pre-pandemic levels. Advertising spend aligned with expectations. Strong engagement in gaming, particularly with the Star field launch.

·       Commercial Bookings:

Increased by 14% (17% in constant currency), driven by core annuity sales motions. Growth in $10 million plus contracts for both Azure and Microsoft 365.

·       Microsoft Cloud:

Revenue of $31.8 billion, growing 24% (23% in constant currency), exceeding expectations. Gross margin percentage increased to 73%, driven by improvements in Azure.

·       Segment Results:

Productivity and Business Processes: Revenue of $18.6 billion, growing 13% (12% in constant currency), driven by Office 365 Commercial and LinkedIn. Intelligent Cloud: Revenue of $24.3 billion, growing 19%, with better-than-expected results across all businesses, especially in Azure. More Personal Computing: Revenue of $13.7 billion, increasing 3% (2% in constant currency), with positive results across all businesses.

·       Headcount and Operating Income

Total company headcount was 7% lower than a year ago. Operating income increased by 25% (24% in constant currency), with a 5-point increase in operating margins year-over- year

·       Capital Expenditure and Cash Flow

Capital expenditures, including finance leases, were $11.2 billion to support cloud demand. Cash paid for PP&E was $9.9 billion. Cash flow from operations was $30.6 billion, up 32% year-over-year.

Outlook Q2’2024

·       reductivity and Business Processes:

Microsoft predicts a revenue range of $18.8 billion to

$19.1 billion in the Productivity and Business Processes segment. This highlights the company's expectations for growth and market dynamics in its suite of productivity tools.

            ·                                                         Intelligent Cloud:

The Intelligent Cloud segment is projected to generate revenue between $25.1 billion and $25.4 billion. This underscores Microsoft's continued focus on cloud services, particularly Azure, and the expected impact of AI contributions.

·       More Personal Computing:

In the More Personal Computing category, Microsoft forecasts revenue in the range of $16.5 billion to $16.9 billion. This includes insights into Windows OEM revenue, gaming, and other consumer-focused products and services.

·       Cost of Goods Sold (COGS):

COGS is estimated to be between $19.4 billion and $19.6 billion, with an additional $0.5 billion allocated for the amortization of acquired intangible assets from the Activision acquisition. This reflects the costs associated with delivering Microsoft's products and services.

·       Operating Expenses:

Operating expenses are anticipated to fall within the range of $15.5 billion to $15.6 billion, providing a glimpse into Microsoft's planned investments and cost management strategies.

·       Other Income and Expense:

Microsoft expects other income and expense to be approximately $500 million. This includes factors such as interest income, interest expense, and any gains or losses on equity investments.

·       Tax Rate:

The effective tax rate is estimated to be between 19% and 20%, shedding light on Microsoft's tax planning and obligations.

Financial Analysis

·       Revenue Growth:

Microsoft's revenue has consistently risen, reaching $211.9 billion in the first quarter of FY24, reflecting an impressive growth of 68% since 2019. The substantial annual increases demonstrate Microsoft's sustained market strength and ability to adapt. Notably, the Q1 FY24 revenue of $56.5 billion, while slightly lower sequentially, still showcases Microsoft's robust financial performance and ongoing positive trajectory in meeting market demands.

·       Gross Profit Margin and COGS Margin

Over the past five years, Microsoft has demonstrated consistent growth in gross profit (GP) and gross profit margin, showcasing financial strength. In 2024 Q1, the gross profit reached $40.2 billion, achieving a high GP margin of 71%, indicating efficient cost management. Cost of Goods Sold (COGS) increased but was well contained, maintaining a healthy COGS margin of 22%. Gross profit represents revenue minus COGS, reflecting the profitability of core operations, and these trends affirm Microsoft's financial resilience and effective operational management.

·       Net Profit

Over the past five years, Microsoft's net profit has shown a consistent upward trend, reaching $72.4 billion in 2023. The growth reflects the company's robust financial performance. Notably, the first quarter of the following year contributes an additional $22.3 billion, indicating a strong start. This sustained profitability underscores Microsoft's effective business strategies and market positioning, providing a positive outlook for future financial success.

·       Return on Capital Employed

Microsoft's Return on Capital Employed (ROCE) surged from 40% in 2019 to an impressive 111% in 2023, reflecting consistently robust financial performance and efficient capital utilization over the years.

·       Trading Multiples

1.       EV/FCF: Microsoft's Enterprise Value to Free Cash Flow ratio fluctuated, reaching a peak in 2023, indicating variations in market sentiment and cash flow performance.

2.       EV/SALES: Microsoft's Enterprise value to sales ratio indicates resilience, with a minor dip in 2023, showcasing sustained market confidence despite fluctuations.

3.       EV/EBITDA: The ratio reflects a consistently strong valuation, with a slight dip in 2023, showcasing stable earnings before interest, taxes, depreciation, and amortization.

4.       P/E: The Price to Earnings ratio remained relatively high, reflecting investors' confidence in Microsoft's future earnings potential, even with a minor decrease in 2023.

§  WACC/LTGR Sensitivity Analysis

The provided WACC sensitivity data reveals the impact of varying Weighted Average Cost of Capital (WACC) and Long-Term Growth Rate (LTGR) scenarios on the enterprise's valuation. As WACC increases from 5.8% to 7.75%, the enterprise's valuation (in million units) decreases across LTGR levels, indicating higher discount rates negatively affecting future cash flows. Notably, higher WACC results in lower valuations at each LTGR point. This sensitivity analysis underscores the importance of managing WACC for optimal valuation, as higher discount rates can significantly impact the present value of future cash flows.

§  WACC/Exit Multiple Sensitivity Analysis

The WACC sensitivity data explores the impact of varying Weighted Average Cost of Capital (WACC) and exit multiples on enterprise valuations. As WACC increases from 5.8% to 7.8%, valuations decrease across different exit multiples (12.5x to 20.5x). Higher WACC and lower exit multiples result in lower valuations, reflecting increased discount rates and reduced terminal values. For instance, at a 15.5x exit multiple, the valuation ranges from 422.6 at 5.8% WACC to 393.8 at 7.8% WACC. This analysis highlights the inverse relationship between WACC, exit multiples, and enterprise valuations in a sensitivity scenario.

DuPont Analysis

·       DuPont Summary

1.       ROE Growth: Microsoft's Return on Equity (ROE) showed a steady increase, reaching its peak in 2022 at 84%, indicating improved profitability relative to shareholder equity.

2.       Asset Utilization: The Asset Turnover ratio remained constant at 0.5x, signifying consistent efficiency in generating revenue from assets.

3.       DuPont Analysis: The rising ROE can be attributed to sustained profitability (ROE = Net Profit Margin - Asset Turnover), where consistent asset turnover played a crucial role.

4.       Stable Efficiency: Microsoft maintained a consistent Asset Turnover, demonstrating stability in utilizing assets to generate sales throughout the period.

5.       Overall Performance: The DuPont analysis suggests that Microsoft's ROE growth primarily resulted from both increased profitability and stable asset utilization, showcasing a robust financial performance.

Valuation

·       Terminal Value and Gordon Growth Rate:

The Terminal Value of Microsoft is estimated at $21,23,241 with a long-term growth rate of 2.1%.

·       Discounted Cash Flow (DCF) Analysis:

The Present Value of Terminal Value is $15,85,645, contributing to an overall DCF Value of the Operating Business at $19,04,856.

·       Non-Operating Assets and Total Firm Value:

Non-Operating Assets add $74,922 to the Total Value of the Firm, resulting in a valuation of $19,79,778.

·       Debt and Cash Adjustment:

Gross Debt & Debt Equivalents subtracted ($71,502), while Cash added $80,452, with no Non-Controlling Interest considered.

·       Equity Value and DCF Value per Share:

The DCF Value of Common Equity is $19,88,728, divided by the No. of shares outstanding (7,431), yielding a DCF Value per Share of $268.

This valuation suggests a comprehensive assessment of Microsoft's intrinsic worth, factoring in operating and non-operating elements, contributing to a per-share value based on discounted cash flows.

Disclaimer

This Equity Research Report on Microsoft is created solely for educational purposes and does not constitute financial advice, investment recommendations, or endorsements. The information presented is based on publicly available data and analysis, and while efforts have been made to ensure accuracy, no guarantee is provided. Readers are encouraged to conduct independent research and seek professional advice before making financial decisions. The author and any associated entities shall not be held responsible for any errors, omissions, or actions taken based on the content of this report. Financial markets are subject to risks; therefore, readers should exercise caution and diligence when interpreting and utilizing the information presented in this report.

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