Microsoft (click ticker for report: MSFT) reported stronger than expected earnings Thursday afternoon. Net of a goodwill impairment charge related to the aQuantive write-down, the firm earned $0.73 per share for its fiscal year 2012 fourth quarter, higher than the $0.62 the Street was expecting and 6% higher than in the same quarter a year ago. Revenue grew 7% in the quarter, which was in-line with consensus expectations. More importantly, the firm continues to be a cash cow, generating north of $5 billion in free cash flow during its fourth quarter and over $22 billion in free cash flow for the year. We think shares of the tech giant remain significantly undervalued.
Revenue in the firm’s Windows and Windows Live divisions shrank 13% year-over-year, to $4.1 billion, but such a decline was expected given the success of Windows 7 last year (and a lull caused by Windows 8, which will be released in October). Revenue in the company’s Entertainment and Devices division grew 20%, to $1.8 billion. Most of this increase was due to the acquisition of Skype, yet we think this division has tremendous upside potential. Xbox can now be used as a personal entertainment device rather than just a gaming console, and the next iteration will likely include Blu-Ray, making it a full-service next generation entertainment platform. We think the firm will continue to be the dominant video game console and possibly the dominant next generation full-service entertainment device.
The company’s Servers and Tools division grew revenues 12.6% in its fourth quarter to $5.1 billion, and management noted strength in SQL and the enterprise services business. In our view, Microsoft’s strength in the enterprise market is far more vital to its long-term success than the PC or tablet market, so we expect the firm to continue to invest in high-margin software and services to fit the needs of enterprise customers.
Revenue in Microsoft’s Business Division, also known as MBD, grew 7% year-over-year, to $6.2 billion. This division includes the Microsoft Office Suite, which is the company’s strongest property, in our view. Excel, Word, and PowerPoint are among the most engrained applications in both education and business. More importantly, a true competitor has yet to emerge. Even Google Docs (click ticker for report: GOOG) suffers from limited functionality and fewer features, so we think Microsoft Office programs could become more popular when they are coupled with cloud computing.
With shares of the firm still trading at a significant discount to our fair value estimate, Microsoft remains a very attractive opportunity at current levels. Not only does the firm have upside potential and a hefty margin of safety, but there’s a high likelihood the firm will raise its dividend at a very nice pace going forward. As a result, we hold this cash-cow in the portfolio of our Dividend Growth Newsletter.