We’re raising our fair value estimate for the software giant as its cloud roadmap strengthens.
By Rodney Nelson | 04-28-17 | 12:50 AM | Email Article

On the surface,  Microsoft’s third-quarter headline numbers fell in line to modestly ahead of our expectations. However, we think investors should key in on impressive growth figures from Microsoft’s leading cloud franchises while paying little mind to undulations in hardware. We think Microsoft’s cloud roadmap continues to strengthen for existing and new customers alike, and we are retaining our wide moat rating. After incorporating meaningfully higher commercial cloud growth expectations and a modestly lower long-term tax rate, we are raising our fair value estimate to $77 per share from $68 previously, and we think shares are moderately undervalued today.

Rodney Nelson is an equity analyst for Morningstar.

Third-quarter adjusted revenue rose 6% versus the prior-year period to $23.6 billion, as each of Microsoft’s flagship cloud properties delivered strong performances. Azure revenue rose 93% in the quarter, while Azure premium services (built around themes such as the "Internet of Things," artificial intelligence, and automation), grew in excess of 100% for the 11th consecutive quarter. We believe premium services will serve as key differentiators for leading vendors in the public cloud arena, and we think Microsoft (alongside Amazon Web Services) will continue to establish leadership positions on this front, ultimately yielding long-term competitive strongholds for each company. Most encouragingly, Microsoft is beginning to generate meaningful upswings in Azure gross margins as the utilization and workload mix continues to skew more favorably.

Beyond Azure, Office 365 and Dynamics 365 continue to see strong sales trends, though the latter is off a minimal base today. We think Microsoft is successfully solidifying its wide moat around the Office business, with more than 100 million commercial monthly active users on Office 365, and another 26 million consumer subscription have been sold. Office commercial and consumer revenue (which include both cloud and legacy contributions) rose 7% and 15%, respectively.

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