George Soros advises that a good investment is boring. If so, then Microsoft
(MSFT) – Get the Microsoft Corporation report represents an interesting investment. The software giant is well-diversified and steadily growing, with few thrills along the way.
cloud wars
Microsoft’s ambitions to be the dominant player in the cloud are set to become increasingly difficult as the amount of specialization required from customers causes this space to become increasingly fragmented.
Unfortunately for investors, figuring out which cloud service provider is leading is a dreadfully cumbersome task, as companies report their numbers very differently. Nevertheless, industry reports generally place Amazon
(AMZN) – Get the report from Amazon.com, Inc. AWS as the leader, with Microsoft’s Azure as a solid number two. Third place goes to IBM
(IBM) – Get International Business Machines Corporation report Cloud and then come Alphabet’s
(GOOGL) – Get the Class A report from Alphabet Inc. Google Cloud Platform and Alibaba
(BABA) – Get the report from Alibaba Group Holding Ltd. Cloud.
Moreover, as is well known, Amazon had the incredible foresight to recognize the opportunity years before any other tech giant and define the industry. However, as history repeatedly demonstrates, the first-mover advantage is not always very significant. You can think of Internet search engines, mobile phones, cars, social media (MySpace). The first mover advantage is expensive. Still, Amazon’s entrepreneurial spirit got AWS off the ground, and for now, it’s still the leader.
As IBM moved slowly, once it recognized both the opportunity at hand and was falling behind, IBM stepped out and in a instinctive move deployed a third of its market capitalization to the time and bought Red Hat for $34 billion in October 2018.
As a result, IBM’s knowledge of this space, combined with its inability to develop this overall platform in-house, shows how exhausting hybrid cloud development can be.
So, although Azure was developed years after AWS, Azure’s convenience and reliability allow it to continually take market share in this space. Finally, as an added bonus for Microsoft, Azure is able to leverage its existing distribution system to get its software into the hands of end users.
High margins
As noted above, each company reports different metrics for their cloud activities. While Amazon is arguably the most transparent, AWS’ operating margin is less than 30% for 2018. from the SEC that its very high gross profit margins continue to benefit Azure.
Microsoft grew its Intelligent Cloud revenue by 24% in its December quarter, with Azure continuing to grow revenue by more than 75% year-over-year. Microsoft’s last twelve months generated a consolidated operating margin of 32.8%, suggesting that Azure’s margin could be significantly higher than that of Amazon’s crown jewel.
Valuation – Significantly undervalued
At first glance, Microsoft shares appear to be fully priced, especially relative to their historical valuation. Specifically, at an operating P/Cash Flow of 19.3x, Microsoft appears to be inflated from its historical valuation of 15.6x. However, this superficial analysis misses two critical points.
First, Microsoft’s balance sheet ended the second quarter of 2019 with over $125 billion in cash and cash equivalents, which makes its 2014 year-end balance of $86 billion seem small by comparison. As a result, Microsoft’s financial position is significantly stronger than at any time in the past five years.
Second, Microsoft is significantly more diversified today than it has been historically. And while Microsoft’s Productivity and Business Process segment generates slightly more profit than its other segments, it has less near-term growth potential than its Intelligent Cloud segment.
Last words
Azure is more than a platform, it’s a brand trusted by businesses. Not only is the cloud market growing rapidly, but the industry track is very long, with years if not decades of growth ahead. Above all, investing in a diversified giant like Microsoft leaves investors with a huge margin of safety.
Microsoft, Amazon and Alphabet are stakes in Jim CramerAction Alerts PLUS Charitable Trust Portfolio. Want to be alerted before Cramer buys or sells those stocks? Learn more now.
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I have no position in the stocks mentioned.
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