A closer look: Microsoft Corp. (MSFT)

Holding Name: Microsoft Corporation (NASDAQ: MSFT)

Strategy: Flagship

Percent weighting of strategy: ~5.8%

TLDR: Microsoft (MSFT) remains the clear enterprise platform leader and should continue to take wallet share in the face of shrinking IT budgets into 2023. Despite weaker than expected guidance, we believe the company can innovate through recession fears and come out the other side a better, financially stronger business. 

Business overview: Microsoft Corp (MSFT) develops, licenses, and supports software products, services, and devices for enterprises and individuals around the globe.The company offers a comprehensive range of operating systems, cross-device productivity applications, server applications, software development tools, business solution applications, desktop and server management tools, video games, and training and certification services. The company also designs, manufactures and sells PCs, tablets, gaming and entertainment consoles, and other intelligent devices.

The company’s core business segments include Productivity and Business Processes, Intelligent Cloud, and More Personal Computing. Household brands that Microsoft owns and operates include Office 365, Microsoft Azure, Microsoft Surface, XBox and LinkedIn, to name a few. 

Why we own it: Microsoft is a best in breed compounder that has created deep competitive moats while being able to continuously innovate in an effort to drive next generation product development for businesses and individuals around the globe.

With over 50% of their revenues recurring in nature (subscription-like), Microsoft has a tremendous tailwind in cloud revenue growth, where it is seamlessly integrating its on-premise servers with its Azure cloud offering. As it continues to gain economies of scale, cloud computing margins will greatly benefit the business over the long-term. 

Ultimately, MSFT should be valued more like other subscription software businesses and we continue to be confident in the company’s ability to grow despite market volatility. 

What’s the latest: MSFT reported earnings after the bell on Tuesday and although the company produced a solid quarter, it was still weaker than what the Street expected. 

MSFT beat on top and bottom line which was largely driven by strong underlying performance and execution across most business lines. However, the combination of a 3% year over year headline decline in commercial bookings and a guidance miss for all three reporting segments for FQ2 has the stock under significant pressure. While the growth at scale across many of its divisions continues to impress, incremental macro headwinds are starting to show.

Enterprise IT budgets seem to be holding up better than expected, but there is still weakness and incrementally more pushback on price uplifts. CFO Amy Hood noted that "We continue to see healthy demand across our commercial businesses including another quarter of solid bookings as we deliver compelling value for customers" but mentioned that the company expects 2Q productivity sales and intelligent cloud sales to be lower than originally guided. 

Sign posts moving forward: Microsoft reported solid fiscal Q1 results on the back of Azure & O/M 365 growth; however, management reduced its previous Q2 and FY23 guidance due to intensifying macro headwinds. 

While PC weakness was a key driver, investors are notably concerned with continued decelerating Azure growth. Our focus continues to be on Azure and the commercial office business, while acknowledging that its consumer and advertising exposure will serve as notable headwinds near-term.

The content contained in this material is intended for general informational purposes only and is not meant to constitute legal, tax, accounting, solicitation of an offer, or investment advice.

Disclosure