After another quarter of torrid cloud growth and resilient Windows results, we’re increasing our view of the firm’s growth and profitability.
By Rodney Nelson | 01-26-17 | 09:05 PM | Email Article

 Microsoft’s second-quarter results came in ahead of our expectations as we continue to see the business’s results increasingly driven by cloud products. The firm saw another quarter of torrid growth in its Azure business, while Office 365 adoption continues at a strong clip. Conversely, the company experienced the usual choppiness in its hardware businesses, as phone revenue continues to crater against the cyclical Xbox and Surface businesses. We think sales will continue to tilt toward cloud-based, moat-bearing products and services, and we will maintain our wide moat rating for Microsoft. We are raising our fair value estimate to $68 per share from $63 previously as we expect faster adoption of Microsoft’s cloud products and ramping profitability, though shares look close to full value today.

Rodney Nelson is an equity analyst for Morningstar.

Second-quarter non-GAAP revenue rose 2.2% (up 4% in constant currency) versus the prior-year period to $26.1 billion, ahead of our expectations. LinkedIn contributed just over $200 million in revenue in the three weeks between the merger close date and the end of the quarter. We expect to see aggressive investment in new functionality centered around LinkedIn in products such as Office 365 and Dynamics 365, but we were encouraged to hear the professional social network is driving strong growth from sponsored content and Sales Navigator, the firm’s social selling tool.

The core Microsoft business remains defined by its cloud products, but we continue to be pleasantly surprised by the resiliency of the Windows business. We have maintained that the death of Windows has been greatly exaggerated, and the platform has undergone something of a renaissance behind Windows 10, with Surface Pro, Surface Book, Xbox and OEM devices driving strong adoption. We continue to see long-term optionality in the Windows business via HoloLens AR and lower-cost VR devices, but if nothing else we have greater confidence that Windows can help buoy results as cloud profitability grows.

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