Image Source: Microsoft Corporation – Fourth Quarter of Fiscal 2020 IR PowerPoint Presentation

By Callum Turcan

Our favorite way to ride out the ongoing coronavirus (‘COVID-19’) pandemic is large-cap tech companies, particularly those with high quality cash flow profiles, pristine balance sheets, and strong growth outlooks supported by secular growth tailwinds. Microsoft Corporation (MSFT) fits that bill perfectly, which is why we include shares of MSFT as a holding in both our Best Ideas Newsletter and Dividend Growth Newsletter portfolios. We added shares of MSFT back to both of those newsletter portfolios on June 12 (link here) and we increased the weighting of MSFT in both newsletter portfolios on August 20 (link here).

Overview

Microsoft offers investors a combination of income growth and capital appreciation upside. Shares of MSFT yield ~1.0% as of this writing and given its large net cash position and high quality cash flow profile, we see room for Microsoft to push through annual double-digit (per share) dividend increases over the coming years. Our fair value estimate for Microsoft sits at $216 per share (above where shares are trading at as of this writing) with room for upside as the top end of our fair value estimate ranges sit at $259 per share. To check out our 16-page Stock Report covering Microsoft, click here.

As of June 30, Microsoft had $136.5 billion in cash, cash equivalents, and short-term investments on hand. As an aside, Microsoft also had $3.0 billion in equity investments on hand as of the end of June 2020. Stacked up against $3.7 billion in short-term debt and $59.6 billion in long-term debt, Microsoft’s $73.2 billion net cash position (not including its equity investments position) at the end of fiscal 2020 (period ended June 30, 2020) provides the firm with ample firepower to push through dividend increases in the future. Microsoft generated $45.2 billion in free cash flow in fiscal 2020 while spending $15.1 billion covering its dividend obligations and another $23.0 billion repurchasing its common stock, all funded with internally generated free cash flows.

Good News

The US Department of Defense (‘DoD’) awarded Microsoft the $10.0 billion (over ten years) Joint Enterprise Defense Infrastructure (‘JEDI’) contract in October 2019. Here is a brief excerpt from the press release announcing Microsoft’s big win:

The JEDI Cloud contract will provide enterprise level, commercial Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) to support Department of Defense business and mission operations. Work performance will take place at the awardee's place of performance.

However, many other tech giants were also vying for that contract including Amazon (AMZN). After losing out to Microsoft, Amazon protested and filed a complaint, which among other things alleged that the procurement decision process was political (in short, that Amazon lost out to Microsoft because President Trump did not want Amazon to win). On September 4, the US DoD reaffirmed Microsoft’s contract win noting that (emphasis added):

The Department has completed its comprehensive re-evaluation of the JEDI Cloud proposals and determined that Microsoft's proposal continues to represent the best value to the Government.The JEDI Cloud contract is a firm-fixed-price, indefinite-delivery/indefinite-quantity contract that will make a full range of cloud computing services available to the DoD. While contract performance will not begin immediately due to the Preliminary Injunction Order issued by the Court of Federal Claims on February 13, 2020, DoD is eager to begin delivering this capability to our men and women in uniform. 

Though this saga appears to be far from over given the preliminary injunction order mentioned above and Amazon’s ongoing fight to get the award overturned (Amazon recently posted a public blog highlighting its disapproval of recent events that did not go the company’s way), it seems things continue to shift in Microsoft’s favor. In Amazon’s blog post the firm noted that “we will not back down in the face of targeted political cronyism or illusory corrective actions, and we will continue pursuing a fair, objective, and impartial review.” We caution that though Microsoft appears to have kept its contract with the US DoD, Amazon does not appear to be letting up anytime soon.

When it comes to the JEDI contract, what matters most is that Microsoft could potentially build up a long lasting and recurring business with the US DoD that generates sizable cash flows for years if not decades to come. If everything starts to proceed as planned, Microsoft’s growth outlook would improve along the margins and that could help push shares of MSFT into the upper bound of our fair value estimate range. There is also the opportunity for Microsoft to expand the number of services it provides to the US DoD over time by winning future contracts, with a focus on cloud-oriented and IT infrastructure offerings (which in turn could see Microsoft’s cash flows from this side of its business grow over time, at least in theory).

Concluding Thoughts

We continue to like Microsoft as a holding in both our Best Ideas Newsletter and Dividend Growth Newsletter portfolios. The tech giant is extremely well-positioned to ride out the storm created by the pandemic with its financials and dividend growth trajectory intact. As the JEDI story progresses, we will keep our members informed on any significant pieces of new information that comes to light. Members interested in reading more of our thoughts on Microsoft should check out this article here.

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Related: AMZN, GOOG, GOOGL, SPY, QQQ

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Callum Turcan does not own shares in any of the securities mentioned above. Microsoft Corporation (MSFT) is included in both Valuentum’s simulated Best Ideas Newsletter and Dividend Growth Newsletter portfolios. Alphabet Inc (GOOG) Class C shares are included in Valuentum’s simulated Best Ideas Newsletter portfolio. Oracle Corporation is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum's simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.