The Valuentum analyst team talks about the financial strength of Microsoft, its deal with LinkedIn, the possibility of a winner’s curse, its growing cloud business, and a setback with the Surface. ~6 mins.
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Tickerized for Microsoft and Salesforce.
Brian Nelson, CFA
This is Brian Nelson for Valuentum Securities, and today joining me is Mr. Kris Rosemann and Mr. Chris Araos. Today, we would like to talk about Microsoft (MSFT).
We’ve been very very skeptical of its deal with LinkedIn (LNKD) as of late and I think to help us walk through some of our concerns but also the possible benefits of a tie-up with LinkedIn is Kris Rosemann. Kris, what do you think?
Kris Rosemann:
We’ve been generally negative on the long-term (economic value-generating) prospects of the LinkedIn acquisition, but at the same time we are still very fond of Microsoft as a whole. It’s one of our favorite dividend ideas on the market today, and we love its balance sheet strength, which will take a bit of a hit with the LinkedIn acquisition, but it will remain very strong, as the company had $123 billion in cash and cash equivalents at the end of the most recent quarter, the first quarter of fiscal 2017.
Brian:
So it has a war chest to use to invest in the future.
Kris:
Right, and while the LinkedIn acquisition will take up $26 billion dollars of that cash, there is still plenty left over for a substantial cushion for future investments.
Brian:
It seemed like, that within that deal though, Salesforce (CRM) may have been a part of that bidding war. We hear a lot about the “winner’s curse,” right? — where a company ends up overpaying for assets (in a bidding war).
Now, we think that’s what might of happened with LinkedIn, but in a situation with Microsoft though, where its balance sheet is just so strong, its free cash flow is phenomenal, these sorts of investments for the future — it’s sometimes okay to do that.
We continue to hold Microsoft as one of our core dividend growth ideas in the Dividend Growth Newsletter Portfolio, but Microsoft, even throwing its acquisition program aside, it has a lot of good things going for it right now.
Kris:
That’s right — they continue to work towards a transition a more cloud-based, subscription-based software business model. They have seen a lot of great momentum on both the consumer side of things as well as the enterprise side of things.
Azure, its enterprise-grade cloud-based product suite doubled its revenue in its most recent quarter, and Office 365, its cloud-distributed subscription-based, both consumer and commercial productivity suite, continues to see very strong momentum as well. We think these two higher-margin, recurring revenue type areas will only provide benefits to Microsoft’s free-cash-flow generating abilities, and in the long run, help it recoup its balance sheet strength that it might lose with the LinkedIn deal.
Brian:
I see — but Microsoft is a massive company, and while it has a lot of good things going for it, there are also somethings in some areas that are still experiencing weakness. Mr. Araos what comes to mind in that department?
Christopher Araos:
Microsoft just recently introduced a new all-in-one pc in the hopes that they will revitalize the PC market…
Brian:
…and we just saw in most recent quarter that Apple’s (AAPL) Mac sales were down 14%. What does that really speak to in terms of Microsoft’s opportunities for this all-in-one, if Apple has the mindshare, the eco system? It really doesn’t bode well for Microsoft in this particular segment, right?
Christopher:
Yes, it seems like consumers are pivoting towards smartphones and tablets [moble] instead of purchasing the giant personal computers…
Brian:
Even in Intel’s (INTC) most recent quarter, we saw a little concern about the PC market. Worldwide PC shipments are down 5.7%, or were down 5.7% in the most recent period. Microsoft is still trying to hang on to an area of their business that is not really growing. They will not be able to do extremely well because the end market is just not there anymore.
Christopher:
Yes, that why it seems there is more interest in the Surface tablet because it is more mobile and it comes with a foldable keyboard.
Brian:
You have an interesting anecdote Mr. Rosemann about the Surface tablet though in terms of how marketing can go wrong, and cut both ways.
Kris:
Right, so Microsoft recently signed a $400 million advertising deal with the National Football League, in which they would provide all teams with Microsoft Surface tablets to use on their sidelines for whatever purposes they may seem fit. Very recently, New England Patriots Head Coach Bill Belichick, who is among one of the most respected in the league, came out and said he would go back to the old fashioned way of doing things just using pictures and things like that and notebooks — because the Surface Tablets were far too unreliable/undependable and he just did not see them fit for his uses. So it’s just kind of a quirky anecdote on how advertising can backfire when you take things out of your own hands.
Brian:
It’s an interesting anecdote for sure. We will see how the Surface sales react to that in the coming periods.
But we continue to like Microsoft as a whole; here we have a very large company with a variety of moving parts, but a very fitting theme of the Valuentum way — strong free cash flow generation, a huge amount of cash, net cash on the balance sheet, potential growth opportunities across various lines of its business — and how can we forget, a very very strong dividend with a very nice yield.
This is Brian Nelson. Thank you for joining us.