MICROSOFT
Raunak Onkar, fund manager and head of research, PPFAS
A tech giant and one of the world's largest productivity software providers. A household name because of their Windows Operating System and MS Office products. Organisations, homes, institutions, almost everyone who needs a computer is a customer or a likely customer. However, despite having 80%+ penetration in some of their software categories, their product business has been growing very slowly as demand is not that fast.
They have a new class of business which continues to help them grow and compete in the global tech market - their cloud computing services business. It is one of the top three cloud service providers along with AWS and Google Cloud Platform and has been growing pretty fast.
Why we bought Microsoft so late: It was a miss. I assumed incorrectly that Microsoft won't be able to transition quickly from their legacy software products business to the demands of the new services ecosystem. Microsoft has performed admirably well and still remains reasonably priced despite the valuation being north of $1.2 trillion. They generate healthy cash flows and earnings. Compared to the growth rates of some of the large tech giants who provide essential services to the world, we have some consumer product businesses in emerging markets which don't grow as fast but are still valued at north or 70-80 times their earnings. I think on a relative valuation basis itself it makes a compelling argument to invest in the large tech businesses.
Dan Romanoff, Morningstar analyst
- Economic Moat: Wide
- Economic Moat Trend: Stable
- Fair Value: $196
- Fair Value Uncertainty: Medium
- Stewardship Rating: Exemplary
Since taking over as CEO in 2014, Satya Nadella has reinvented Microsoft into a cloud leader. In our view, Microsoft has become one of two public cloud providers that can deliver a wide variety of PaaS/IaaS solutions at scale. Additionally, Microsoft has accelerated the transition from a traditional perpetual license model to a subscription model. The company has also embraced the open-source movement. Finally, Microsoft exited the low-growth, low-margin mobile handset business and is driving Gaming to be more cloud-based. These factors have combined to drive a more focused company that offers impressive revenue growth with high and expanding margins.
We believe that Azure is the centerpiece of the new Microsoft. Even though we estimate it is already an approximately $7 billion business, it grew at a staggering 92% rate in fiscal 2018. Azure has several distinct advantages, including that it offers customers a painless way to experiment and move select workloads to the cloud. Since existing customers remain in the same Microsoft environment, applications and data are easily moved from on-premises to the cloud. Microsoft can also leverage its massive installed base of all Microsoft solutions as a touch point for an Azure move. Azure also is an excellent launching point for secular trends in AI, business intelligence and Internet of Things, as it continues to launch new services centered around these broad themes.
For Microsoft overall we assign a wide moat rating arising from switching costs, network effects, and cost advantages. We believe that Microsoft's different segments and products benefit from different moat sources.
AWS has taken the market by storm, with Azure trailing, but the two are seen as clear leaders. This is a rapidly evolving market and Microsoft must continually adjust its offerings, add solutions to the stack, and compete with a company that has built a business around aggressive pricing.
