Microsoft Corporation

Written by Ophir Gottlieb, 6-12-2015



Microsoft has long been an inflexible and slow to adapt company. The fact that the firm has totally missed everything with respect to mobile phones is in many ways one of the great corporate failures ever for such a high quality firm. But something is happening now; something unimaginable. MSFT is adapting. MSFT is becoming flexible. MSFT is competing. And now, MSFT may be winning.

The most interesting thing that MSFT is doing surrounds how it has opened up its platform to other operating systems. With an investment in Cyanogen, which creates its own flavor of Android, MSFT has boldly thrown an even greater monkey wrench into the Android chaos, with many versions of the OS totally out of Google's control. Microsoft's adaptability and dare we say, flexibility, are proving to be stunning changes from the once stodgy and immovable firm of the past decade. And let us not forget business cloud computing which is on track for over $6 billion revenue this year. More that, later.

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Another of the most interesting facts surrounding MSFT is how much the firm spends on research and development (R&D). In fact, it spends more than every company in North America across all sectors other than Intel (INTC). In the scatter plot below we chart R&D on the y-axis and equal space the x-axis.


Here are the fundamentals that drive the 3.5 star rating.


MSFT is up +9.9% over the last three months and down -2.2% over the last six months. The stock price is up +12.9% over the last year.

Before we dig into the fundamental trends that drive the rating, let's look at a two-year stock chart with regression channel and 10-day momentum (on the bottom).


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There is good news and bad news for MSFT in its fundamentals. Revenue is one of the "good," as it has risen 9.2% in the last year and nearly 25% from two-years ago. In fact, MSFT now stands at an all-time high in revenue for any trailing-twelve-month period.

Last reporting period MSFT stated that commercial cloud revenue grew 106% (up 111% in constant currency) driven by Office 365, Azure and Dynamics CRM Online, and is now on an annualized revenue run rate of $6.3 billion.

What do all these numbers mean?
MSFT's fundamental rating benefited these results:
1. The one-year change was positive (but no extra points were given for a large percentage increase).
2. The two-year change was positive.



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We can briefly look at MSFT (orange line) vs. AAPL (blue line) and GOOGL (green line) revenue (TTM) through time. MSFT has paced Google well, it's Apple of course that is the wild outlier. Again, revenue isn't the issue for MSFT. But there is an issue.



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This is where the trouble lies for MSFT. Not only is net income (TTM) lower than it was a year ago, it has been down five consecutive quarters (which triggers a "trend"). We've plotted the trailing-twelve-month number in the blue bars and the quarterly number in the orange line. Note that the TTM number hasn't been this low since June of 2010.


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Interestingly, as net income is dropping rather abruptly, levered free cash flow (FCF) TTM is growing. In fact, year-over-year it's up a remarkable 27%. However, compared to two-years ago, the number has barely moved. Remember, the thesis here is that MSFT has been "stuck," and that it is now ready to become "unstuck."

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We discussed R&D at the top and the massive spend that MSFT is on. If we measure R&D per dollar of revenue it's actually pretty steady, but I do note the overall number. The bullish thesis for MSFT is that this expense, right here, is going to turn into an asset which will drive revenue, net income and free cash flow.

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Summary
Microsoft has missed the boat (up until now) on one of the greatest tech opportunities ever in the smart phone. But, there's a whisper that their devices may start selling; in fact, the company reported Phone hardware revenue of $1.397 billion last quarter, up from $0 in the year ago period, and that was nearly exactly the "revenue beat" in last quarter's earnings.

But the whisper is not the excitement here. It's the ROAR from MSFT that it is attacking the echo systems of Google (and maybe AAPL) by finally adapting, changing and leading change rather than insisting its way will work. Don't forget about the greatness that once was MSFT, because it may be coming back.

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