Image Shown: Shares of Microsoft Corporation continue to make new highs and we think MSFT may test the upper end of our fair value range given the company’s improving growth outlook.
By Callum Turcan
Shares of Dividend Growth Newsletter portfolio holding Microsoft Corporation (MSFT) continue to climb higher. We think shares could test the upper end of our fair value estimate range, which currently sits at $166 per share, comfortably above where Microsoft’s stock is trading at as of this writing (~$149 per share). Recent events have augmented the company’s free cash flow potential, with an eye towards the Joint Enterprise Defense Infrastructure (‘JEDI’) contract win. Shares of MSFT yield ~1.4% as of this writing.
Microsoft Wins
The US Department of Defense (‘DoD’) announced it had awarded Microsoft the JEDI cloud computing contract in late-October 2019, which is worth up to $10.0 billion over ten years. This is a deal that will see Microsoft provide cloud computing services on the enterprise level to the various branches of the US military including such offerings as: “commercial Infrastructure as a Service (‘IaaS’) and Platform as a Service (‘PaaS’) to support Department of Defense business and mission operations.”
While the major tech giants that lost out to Microsoft are planning legal and other actions to try and get the JEDI contract nullified or altered, for now it appears that Microsoft will get to reap the spoils of the huge investments it made in cloud computing over the past several years. We will be monitoring this situation closely going forward.
Please keep in mind that just months prior, Microsoft vendors won a major contract with the DoD and the US General Services Administration (‘GSA’), which is known as the Defense Enterprise Office Solutions (‘DEOS’) contract. That deal is estimated to be worth $7.6 billion over a ten-year period. The announcement stated that:
The U.S. General Services Administration and U.S. Department of Defense today announced the award of the Defense Enterprise Office Solutions (‘DEOS’) Blanket Purchase Agreement (‘BPA’), which is built on the Microsoft O365 platform, to CSRA LLC [owned by General Dynamics Corporation (GD)] and its Contractor Teaming Partners Dell Marketing L.P. [owned by Dell Technologies Inc (DELL)] and Minburn Technology Group LLC [which appears to be privately-held].
DEOS represents an enterprise based set of capabilities that include: productivity tools such as word processing and spreadsheets, email, collaboration, file sharing, and storage. DEOS will be used to replace legacy DOD IT office applications with a standard cloud-based solution across all military services.
What makes the JEDI contract so important is that it gives Microsoft’s cloud segment a huge boost at a time when the company is already firing on all cylinders (see our thoughts on Microsoft’s latest earnings report here). Microsoft could see this contract upsized and extended if all goes well.
Cash flow from government contracts, especially those with the DoD, are generally insulated from macroeconomic forces considering the funding is allocated by Congress (meaning that once the project has been approved and the relevant contracts are in force, the cash flows are usually well-protected as Congress has historically ensured the DoD remains well-funded and lives up to its contractual obligations) and offer tremendous room for upside should there be a need for additional services (Congress has historically allocated a lot of funding towards the DoD as a percentage of the federal US budget).
As cloud computing is the future of IT infrastructure (more and more functions, back office and otherwise, will be powered by remote data centers going forward in our view), there’s room to believe that could be the case here. Market researchers believe growth in cloud computing-related spending (particularly public cloud computing services) will continue to climb at a decent rate over the medium-term, keeping exogenous headwinds in mind. Here’s a choice quote from Microsoft’s CEO Satya Nadella during the firm’s latest quarterly conference call:
“Our Commercial Cloud business continues to grow at scale as we work alongside the world’s leading companies to help them build their own digital capability. Microsoft provides a differentiated technology stack spanning application infrastructure, data and AI, developer tools and services, security and compliance, business process productivity and collaboration. First, each of these areas represents secular, long-term growth opportunities; second, we’re delivering best-in-class innovation and openness in each layer; and third, we offer unparalleled integration and architectural coherence across the entire stack to meet the real world needs of our customers.
Now, I’ll briefly highlight how we’re accelerating our progress in innovation, starting with Azure. Organizations today need a distributed computing fabric to meet their real world operational sovereignty and regulatory needs. This quarter, we opened new data center regions in Germany and Switzerland. And in India, we’re bringing the power of Microsoft Cloud to millions of small businesses through our partnership with Jio [a subsidiary of Reliance Industries], one of the largest mobile carriers in the country. Every Fortune 500 customer today is on a cloud migration journey, and we are making it faster and easier.”
Concluding Thoughts
We continue to like Microsoft as a holding in our Dividend Growth Newsletter portfolio and think shares of MSFT could test the top end of our fair value estimate range given its strong technical performance of late, the JEDI contract win, and improving growth outlook. Microsoft last increased its dividend in September 2019, boosting its per share payout by 11% sequentially, and there’s room for plenty of additional dividend growth given the company’s solid free cash flows and pristine balance sheet.
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Callum Turcan does not own a position in any of the securities mentioned above. Microsoft Corporation (MSFT) and Oracle Corporation (ORCL) are both 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.