2. 2
Table 1: Summary of Market Data
Source: Yahoo! Finance
Table 2: Summary of Financial Data
Financial Overview 2014 2015 2016
Revenue growth 12% 8% -9%
gross Margin 69% 65% 62%
EBITDA growth 4% 4% -19%
EBITDA margin 37% 36% 32%
Net Profit Margin 25% 13% 20%
ROA 11% 10% 7%
ROE 26% 14% 22%
EBIT / Interest Exp. 46.7x 36.1x 17.1x
LT Debt/Equity 23% 35% 57%
Source: Company data
Table 3: Summary of Valuation Data
Source: Team estimate
Johns Hopkins University
Carey Business School Student Research
Investment Recommendation: BUY; Target Price: $70
Investment Summary
Microsoft Corporation (I) Pvt. Ltd. (''MSFT" or the "Company") is an American
productivity and platform company. There are three businesses from MSFT's reportable
operating segments: Productivity and Business Processes, Intelligent Cloud and More
Personal Computing.
Investment Recommendation
We issue a BUY recommendation on MSFT with a 12-month target price of $70 per share
from June 30, 2016 closing price of $51.17. Our target price is calculated by (1) Discounted
Free Cash Flow model, and (2) public comparable companies approach to forecast 12-
month target price.
Investment Thesis and Outline
Microsoft Corporation was world's largest software maker by revenue. Based on the
result of DCF and industry analysis, the company’s stock price is presently undervalued.
This undervaluation of shares represents the high increase potential for MSFT as a
platform and productivity service provider. Combined with risk analysis to detect
investment risks and reevaluate its enterprise value after acquiring LinkedIn, we
concluded a Buy recommendation.
Positive Industry Outlook. The overall performance of the three industry is foreseeable
steady growth in the coming years. The three main segments, productivity and business
process, intelligent cloud and more personal computing are all projected to grow
steadily.
Intelligent Cloud as the most significant driven force for the continuous growth of
Microsoft, still has enormous potential to not only attract profit for the company but also
become a key technology to change working environment and increase productivity for
future development.
Multiple ways of Valuation, using the Discounted Free Cash Flow to firm(“DCF”), Public
Comparable Companies valuation and Comparable M&A deals to value Microsoft’s
enterprise value and its share price.
Investment Risk, including regulatory risks, market risks, economic risk and operation
risks were assessed by impact and probability to occur and ranked in a risk matrix
respectively. Risk mitigation factors are provided as well.
Figure 4: History Share Price
Source: Yahoo! Finance
0
10
20
30
40
50
60
70
SharePrice
Adj Close
Market Data (as of Apr 12, 2017)
Previous Close 65.48
Open 65.42
Bid 65.25 x 300
Ask 65.27 x 300
Day's Range 65.11-65.51
52 Week Range 48.04-66.35
Volume 15,410,344
Avg. Vol 22,577,233
Market Cap. 504.07B
PE Ratio (TTM) 30.7
EPS 2.12
Valuation
Results
Base
Case
Bull
Case
Bear
Case
Methodology
DCF 70.19 76.40 64.33
Trading
Multiple
65.25 94.23 59.46
Acq. Multiple 75.37 82.48 68.27
Microsoft Corporation, NASDAQ: MSFT
3. 3
Figure 5: Total Revenue ($ in 000s)
Source: Company Data, Team Estimate
Figure 6: 2016 Revenue by Segments
Source: Company Data
Figure 7: Net Income ($ in 000s)
Source: Company Data, Team Estimate
Business Description
Microsoft Corporation was founded in 1975 and is an American multinational technology
company that develops, manufactures, licenses, supports and sells computer software,
consumer electronics and personal computers and services. In June 2015, Microsoft
Corporation announced a change in organizational structure to align with their strategic
direction as a productivity and platform company and divided their operating segments
into Productivity and Business Processes, Intelligent Cloud, and More Personal computing.
On December 8
th
, Microsoft and LinkedIn announced an agreement to join force to
connect the world's professional cloud and the world's professional network. Also, in
2016, Microsoft Corporation was world's largest software maker by revenue.
Productivity and Business Processes
Productivity and Business Processes segment aims to improve productivity,
communication and information services to customers and consists three main
categories, including Office Commercial (volume licensing and subscriptions to Office 365
commercial for products and services), Office Consumer (Office sold through retail or
subscriptions), and Dynamics business solutions. Productivity and Business Processes
segment remains stable based on revenue contribution during last five years.
Intelligent Cloud
Intelligent Cloud segment consists of public, private and hybrid server products and cloud
services that can power modern business. It comprises server products and cloud services
and enterprise Services. With more than 70 percent of Fortune 500 have at least two
different Microsoft Cloud offerings and more than 80 percent of world's largest banks are
Azure users, Microsoft is one of the two enterprise cloud leaders.
• Server products and cloud services
Server products provide IT professionals, developers and their systems are more
efficient. Azure is a scalable cloud platform, whose competitive advantage includes
enabling a hybrid cloud, allowing deployment of existing datacenters with our
public cloud into a single, cohesive infrastructure, and the ability to run at a scale
that meets the needs of businesses of all sizes and complexities.
• Enterprise Services
Enterprise Services offer enterprise consulting, managing and deploying Microsoft
server and desktop solutions and provide training and certification to IT
professionals on Microsoft products.
Intelligent Cloud is one of the most significant driven force behind the continuous growth
rate of Microsoft Corporation, posting year-over-year revenue growth of 10%, 9% ,6%
and 8% in 2014, 2015, 2016, 2016 Q3. Specifically, Azure contributes to 116% of the
revenue growth. The high speed growth also reflects positive influence of transformation
and that investors have confident in Microsoft to close the gap on front-runner Amazon
in this segment and continue increase to offset other lost revenue.
More Personal Computing
More Personal Computing segment includes Windows, Devices (Microsoft Surface,
phones, and PC accessories), Gaming (Xbox), and searching advertising. More Personal
Computing decreased 6% mainly due to the decreased revenue of Devices and Windows
which offset the higher growth of Gaming and Searching Advertising.
4. 4
Figure 8: Company Structure
Source: Company Data
Figure 9: Shareholder Structure
Source: Company Data
Figure 10: MSFT SWOT Analysis
Source: Team estimate
The hardware business started to contribute less in recent years but they are still
important part in the whole Microsoft ecosphere and work effectively with other
Microsoft tools. Also, compared to other competitors, like Google, IBM, Microsoft Office
tools remain the most widely-used, flexible and easy-to-use productivity suites, those
network effect makes enterprises continue to subscribe Microsoft products due to high
switching costs and efficiency.
Company Strategy
Microsoft Corporation's strategy is to build best-in-class platforms and productivity
services for a mobile-first, cloud- first world by reinventing productivity and business
processes, building the intelligent cloud platform, and creating more personal computing.
Mobile-first, Cloud-first
In 2016, Microsoft Corporation was still focusing on transforming the organization to
support its strategy to build best-in-class platforms and productivity services for a mobile-
first, cloud- first world. The strength of intelligent Cloud segment has already showed on
its financial statements and become the leading driven force to future revenue. Based on
Gartner's report, the overall global public cloud market is entering a period of
stabilization, with its growth rate peak at 2017 and slow down over next few years. Based
on same vision and ambition, Microsoft and LinkedIn announced an agreement to join
force to connected the world's professional cloud and the world's professional network,
which make labor markets work better for everyone to make them more efficient and
open.
Acquiring LinkedIn was only a step away to build a comprehensive Microsoft ecosystem,
Microsoft will continue combining various cloud products with Microsoft tools as an array
of cloud products, which will become Microsoft's core competitiveness and will help
attract developer with different needs and keep users in Microsoft ecosystem.
Attract and retain qualified employees
As of June 30, 2016, Microsoft Corporation had 114,000 full-time employees, 55% on U.S.
basis and 45% on international basis. Attracting and retaining qualified employees is also
a significant factor to Microsoft Corporation's success. Developing advanced technology,
providing premium-quality services and becoming lead in industry all depend on talented
individuals. Microsoft hire talented employees in various universities and industries
through worldwide by offering them healthy company environment, resourceful career
experiences, and competitive compensation and benefits.
Continued R&D investment in emerging technology trend
Research and development expense remained approximately a constant 13% of total
revenue through last three years. To adapt with key technology trends, narrow the gap
with competitors, and keep its leading position, Microsoft Corporation will continue
make significant research and development investment, especially in Intelligent Cloud
segment. The strategy of in 2016, R & D expense of Intelligent Cloud segment increased
21 percent. As Microsoft announced the sale of its entry-level feature phone business,
we believe Microsoft will continue make significant investment into Intelligent Cloud
segment and a board range of other researches and technologies to maintain long-term
commitment.
5. 5
Figure 11: Industry Corporate Profit
Source: www.ibisworld.com
Figure 12: Private Investment in Computers
and Software
Source: www.ibisworld.com
Figure 13: US 10-Year Treasury Note
Source: bloomberg
Figure 14: Industry Revenue
Source: www.ibisworld.com
Industry Overview and Competitive Positioning
Demand Drivers
• Corporate Profit
Microsoft Office and Dynamics are enterprise software that helps management to make
more informed decisions. Cost of buying enterprise software is capital expenditure which
tend to increase when the company’s profit is high. During 2017, company profits are
expected increase, resulting in potential opportunity for enterprise software industry
(Figure 11).
• Private Investment in Software
Investment in software from the private sector represent the how heavily the private
companies rely on the information technology. When organizations increasingly rely on
information technology. Potential improvements from using business analytics software
increases. Despite corporate profit downturns in 2015 and 2016, private investment in
computers and software grew strongly over the period and rose at an annualized rate of
4.0%. And private investment in software is expected to increase during 2017 (Figure 12).
• Increase in the number of broadband internet connections in US
Over the past five years, broadband internet connections in the United States has
increased with an annualized rate of 10.0% to 332.1 million. Large businesses use
business analytics software to analyze data about their sales patterns, customer
preferences and other information vital to their performance. And the increase of
broadband connection has provided more convenient access to such data. As business
and analytics and enterprise software packages are closely connected to database
software system, with many of the same software companies, such as Microsoft,
dominating both industries.
• Yield on 10-year Treasury Note
The 10-year treasury note represents the basis cost of borrowing. When the 10-year
treasury bond yield increase, companies are less willing to raise capital and invest in
operations, including purchases of enterprise software. As the 10- year treasury yield is
expected to increase, it poses a potential threat to the industry (Figure 13).
Competitive Positioning
• Productivity and Business Process
The business analytics and enterprise software publishing industry’s upstream is
intellectual property licensing in the US and the downstream is e-commerce and online
auctions, commercial banking and IT consulting in the US. This industry grew strongly
over the past five years, with revenue expanding at an estimated annualized rate of 4.9%,
to total $40.2 billion in 2017 (Figure 14)
The industry has grown steadily due to favorable demand conditions caused by high
business profit and investment. From 2012 to 2017, industry revenue rose at an
annualized rate of 4.9% mainly caused by businesses’ increased technological complexity
and eagerness to adopt efficiency-enhancing software. In 2017, industry revenue is
expected to rise 4.2% to $40.2 billion as declining and slowed corporate profit growth
reduces demand for industry software.
-10
0
10
20
30
Year 2010 2012 2014 2016 2018 2020
% change
-6
-4
-2
0
2
4
6
Year
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
2019
2020
2021
2
2.2
2.4
2.6
2.8
3
3.2
market
yield
Q2 17 Q3 17 Q4 17 Q1 18 Q2 18 Q3 18
0
2
4
6
8
10
12
Year 10 12 14 16 18 20
6. 6
Figure 15: World Cloud Services Market
Source: Gartner, Inc.
Figure16: Financial Overview Of LinkedIn
LinkedIn
(Millions)
2012 2013 2014 2015
Revenue
972 1,529 2,219 2,991
Revenue
growth
86% 57% 45% 35%
Cash from
Ops. 267 436 569 807
OCF growth 100% 63% 30% 42%
Source: S&P Capital IQ
Figure17: Historical Growth By Segment
Business Segments
Historical revenue
growth rate
Productivity and
Business Processes
1%
Linked in 38.80%
Intelligent Cloud 8%
More Personal
Computing & Corporate
and Other
1%
Source: Company filings
Start-up companies are entering the industry to capture the niche markets, while
dominant industry players are continued to expand and acquire small operators.
According to IBISWorld the number of companies are increasing at an annualized rate of
4.5% to 1841 operators in 2017. Large software companies, such as Microsoft, are
replying on acquisitions to hone their product portfolio. Microsoft completed the
acquisition of mobile business intelligence startup Datazen Software, big data company
Metanautix and customer service company Parature.
• Intelligent Cloud
The worldwide public cloud services market is projected to grow 18 percent in 2017 to
total $246.8 billion, up from $209.2 billion in 2016, according to Gartner, Inc. The highest
growth will come from cloud system infrastructure services, which is projected to grow
36.8 percent in 2017 to reach $34.6 billion. Cloud application services is expected to grow
20.1 percent to reach $46.3 billion (Figure 15).
In recent years, major companies have worked through teething problems and are
becoming adept in providing mobile and cloud based software earnings. Cloud computing
entails using a network of remote servers hosted on the internet, rather than a local
server or personal computer, to store, manage and process data. Software as a service is
a delivery method that provides access to software and its functions remotely as a web-
based pay-as-you-use service. Microsoft and IBM have already embraced the shift and
are expected to lead the industry into the lower-cost cloud model. Though Microsoft has
made three price cuts of Azure in the last 6 months, we believe the Microsoft is still very
confident about the possible cost reduction in the fiscal year 2017. And there is no sign
of slowing enterprise adoption of the AWS/Azure model.
• More Personal Computing
Microsoft’s more personal computing segment includes Windows Client, Xbox, Surface,
phones and Bing search advertising. Microsoft saw a stronger than expected, Windows
business as Windows OEM revenue grew 5%, accelerating from last quarter’s flat
performance and outpacing the trend in the PC market, which Gartner estimates declined
3.7% y/y in C4Q. Additionally, Microsoft saw a 52% increase Windows 10 deployments in
enterprise and education. Surface revenue was flat y/y in CC as it continues to phase out
the Surface 3 device. In addition, search revenue grew 11% y/y in CC compared to 10%
last quarter, with improving profitability and growth in Bing from higher revenue per
search and search volume.
Valuation
June 2015, Microsoft Corporation announced a change in organizational structure to align
with their strategic direction as a productivity and platform company and divided their
operating segments into Productivity and Business Processes, Intelligent Cloud, and More
Personal computing.
Discounted Free Cash Flow(DCF)
Since Microsoft has a complicated corporate structure with three main profit segment as
figure 17 shows. Each profit segment has unique revenue growth trend and gross margin.
Thus, we disaggregated its revenue into three main parts and adopted customized
assumptions for each product line. Since the acquisition of LinkedIn was completed by
the end of Q2 in 2017, we also need to consider the future growth of LinkedIn, possible
synergies and cost reductions in its first profit segment which is Productivity and Business
Processes.
7. 7
Figure 19: WACC Calculation
WACC 10.2%
CAPM
Market return 10.50%
beta 1.142
Risk-free rate 2.37%
Cost of Equity 11.65%
Debt and tax shield
Cost of Debt 2.50%
Effective tax rate 21%
Capital Structure
Equity weight 85%
Debt weight 15%
Source: Bloomberg
Figure 20: DCF Valuation Summary
DCF Valuation Summary
WACC 10.2%
LTM growth assumption 3%
Enterprise Value 620,859.10
Net Debt 76,502.00
Equity Value 544,357.10
Shares OS 7,755.00
Share Price
70.19
Source: Company fillings
• Assumptions
The revenue growth for Productivity and Business Processes and More personal
computing was set to inflation rate of 3%, since the revenue of these two profit centers
kept stable in past three years. We adopted the market growth rate 18% for its Intelligent
Cloud sector because MSFT kept shifting its investment to this segment and the whole
market has been growing rapidly as mentioned before in figure 15. We used the historical
growth rate 38.8% for LinkedIn, since this part is experiencing a growth stage with
increasing revenue and operating cash flow, as figure 16 shows.
Cost of Goods Sold (COGS) were assumed to grow as historical average percentage of
sales, since the gross margin should keep stable in short run without technology
advancement.
In forecasting future depreciation, we use the average ratio of depreciation over starting
PP&E over the past three years since Microsoft employs straight line depreciation
method for fixed asset. In terms of capital expenditure, Microsoft stated in its annual
report that “the capital expenditure is expected to increase in coming years in support of
productivity and platform”. Therefore, the capital expenditure forecasting is based on the
industry average ratio of capital expenditure over total depreciation and amortization
expenses which is 1.6, as Appendix 2 shows.
• WACC
We calculated the weighted average cost of capital of MSFT, using 10-year US treasury
bond yield as risk free rate. We used the data from Bloomberg as market return and beta.
Finally, the WACC is 10.2%. (Figure 19)
• Synergy and Long term growth Assumptions
For the terminal value and long-term growth rate, we used the long-term inflation rate
as 3% and calculated the estimated share price at $70.19 per share. The DCF valuation
details are attached as Figure 20. Since the market is volatile, we also performed a
sensitivity test under different WACC and long-term growth rate. (Figure 18) A scenario
test with base case, bull case and bear case were performed to test the results as
assumptions for intelligent cloud and synergies from LinkedIn vary. (Figure 21)
Figure18 Sensitivity Analysis LT Growth
Share
Price
70.19 2% 2.10% 2.20% 2.30% 2.40% 2.50% 2.60% 2.70% 2.80% 2.90% 3.00%
W
A
C
C
8% 84.85 86.28 87.75 89.27 90.85 92.49 94.19 95.95 97.78 99.68 101.65
8.50% 78.24 79.45 80.70 81.99 83.33 84.70 86.13 87.60 89.12 90.70 92.34
9.00% 72.56 73.60 74.68 75.78 76.92 78.10 79.31 80.56 81.85 83.18 84.56
9.50% 67.62 68.52 69.46 70.42 71.40 72.42 73.46 74.53 75.64 76.78 77.95
10.00% 63.28 64.07 64.89 65.73 66.59 67.48 68.39 69.32 70.28 71.26 72.28
10.50% 59.43 60.14 60.86 61.60 62.36 63.14 63.94 64.76 65.60 66.46 67.34
11.00% 56.01 56.64 57.28 57.94 58.61 59.30 60.01 60.73 61.47 62.23 63.01
11.50% 52.93 53.49 54.07 54.66 55.26 55.88 56.51 57.15 57.81 58.48 59.17
8. 8
Figure 21: Scenario Analysis
Scenario
Summary
Base
Case
Bull
Case
Bear
Case
IC Growth
Assumption 18% 20% 16%
Synergy
Assumption 10% 12% 8%
Estimated
Share Price 70.19 76.40 64.33
Source: Team estimate
Figure 22: Public Comparable Companies
Company
Name
TEV/Total
Revenues
TEV/EB
ITDA
TEV/
EBIT
Oracle 4.7x 12.2x 13.4x
Alphabet 5.5x 16.5x 20.8x
Vmware 4.3x 16.5x 20.3x
CA 3.1x 9.8x 10.4x
Salesforce.c
om
7.1x 117.8x NM
Red Hat 6.0x 34.8x 43.7x
Workday 9.9x NM NM
ServiceNow 9.9x NM NM
Citrix
Systems
3.7x 12.3x 16.2x
Splunk Inc 7.8x NM NM
MSFT 5.5x 17.0x 22.5x
Summary
Statistics
TEV/Total
Revenues
TEV/EB
ITDA
TEV/
EBIT
High 9.9x 117.8x 43.7x
Low 3.1x 9.8x 10.4x
Mean 6.2x 31.4x 20.8x
Median 5.7x 16.5x 18.3x
Source: S&P Capital IQ
Figure 25: Revenue Changes of MSFT
Source: Company data.
Comparable M&A Analysis
In order to better evaluate the value of MSFT, we also approached the issue via
comparable M&A deals perspective. We collected significant M&A deals in
technology industry in the past year and calculated the purchase cost/Enterprise
value multiple. Excluding two deals that included the debt, we get an average
multiple 1.13x and a median as 1.09x (figure 24). For conservative purpose, we chose
the median in valuation. Assuming 10%, 20% and 30% purchase premium, we arrived
at share price $68.27, $75.37, and $82.48 per share, figure 23. The results are
approximate the same as the figure we got under three scenarios in DCF valuation.
Figure 23: Comparable M&A Valuation
Source: Team estimate
Figure 24: Comparable M&A Deals
Source: S&P Capital IQ
Public Comparable Analysis
To value Microsoft, we used the comparable company approach as well. We have
selected ten public company who share the similar product and service, country,
company size, current profitability and future growth potential as Microsoft as the
comparable companies. This method is reasonable as all the other comparable
company’s stock price is published daily and all the possible factors that affect the
company’s stock price is contained in the movement of these companies’ stock prices.
We would be using EV/Revenue, EV/EBITDA and EV/EBIT three different multiples
involving comparable companies’ financial results. The enterprise value of Microsoft we
calculated are reasonable since all the comparable companies’ financial results are
audited. For all the three different multiples, we summarized the results and used the
mean and median as two different cases for Microsoft (Figure22). After multiple the
three different multiples with Microsoft’s total revenue, EBITDA and EBIT, we get the
implied enterprise value. After adding back to the total cash and short term
investments, minus total debt and total preferred equity for Microsoft, and divide
73,723
77,849
86,833
93,580
85,320
50,000
60,000
70,000
80,000
90,000
100,000
2012 2013 2014 2015 2016
Revenue (millions)
Fiscal years
MSFT (Millions)
Current Market
Value
504,140
Purchase
premium
Purchase
Price
EV Net Debt Shares OS Share price
10% 554,554 605,944 76,502 7,755 68.27
20% 604,968 661,030 76,502 7,755 75.37
30% 655,382 716,115 76,502 7,755 82.48
(Billions) Approximat
e EV
Acquisition
Cost
Notes Price/E
V
Qualcomm Acquire NXP 33.52 37.11 1.11
Analog Acquire Linear
technology
14.40 14.80 1.03
Quintiles Transnational Acquire
IMS Health
0.70 14.70 including
Debt
21.00
Oracle buys NetSuite 7.20 9.50 1.32
Samsung buys Harman 0.80 8.90 including
Debt
11.13
MSFT Acquire LinkedIn 24.30 26.20 1.08
Average 1.13
Median 1.09
9. 9
Figure 26: EBITDA Margin Compare
EBITDA Margin 2013 2014
Alphabet 35% 33%
CA Inc 34% 32%
Citrix Systems Inc 22% 21%
Oracle 43% 44%
Red Hat Inc 20% 20%
Salesforce com inc 0% -1%
ServiceNow Inc -10% -16%
Splunk Inc -9% -23%
VMware Inc 28% 25%
Workday Inc -33% -25%
MSFT 40% 37%
Average 16% 13%
Median 22% 21%
EBITDA Margin 2015 2016
Alphabet 33% 33%
CA Inc 32% 31%
Citrix Systems Inc 26% 30%
Oracle 42% 40%
Red Hat Inc 18% 18%
Salesforce com inc 5% 8%
ServiceNow Inc -11% -5%
Splunk Inc -45% -40%
VMware Inc 27% 26%
Workday Inc -20% -16%
MSFT 36% 32%
Average 13% 14%
Medean 26% 26%
Source: S&P Capital IQ
Figure 27: Risk Matrix
Source: Team estimate
the results by total share outstanding, we get the implied price per share ranging from
54 to 117.The mean equity value across multiples are 728,140.71 million and
459,507.78 million. The mean price per share across multiples are $94.23 and $59.46.
(Appendix 3)
Financial Analysis
MSFT Overview (Millions) 2012 2013 2014 2015 2016
Revenue 73,723 77,849 86,833 93,580 85,320
Revenue growth 5% 6% 12% 8% -9%
Gross Profit 56,193 57,464 59,755 60,542 52,540
gross Margin 76% 74% 69% 65% 62%
EBITDA 30,714 30,836 32,131 33,572 27,170
EBITDA growth 3% 0% 4% 4% -19%
EBITDA margin 42% 40% 37% 36% 32%
Cash from Ops. 31,626 28,833 32,502 29,668 33,325
OCF growth 17% -9% 13% -9% 12%
Unlevered Free Cash Flow 23,863 19,970 24,130 21,415 17,455
Free Cash flow yield 32% 26% 28% 23% 20%
Overview
In the past five years, MSFT showed strong financial performance with increasing
revenue and operating cash flow, as we can observe from above. Gross margin
decreased because of competition and diversified operations. There was an obvious
revenue drop in 2016 due to 6.6 billion revenue deferral of license fee of Windows
10. The acquisition of LinkedIn has completed by the end of Q2 of 2017. Therefore,
we consider LinkedIn as a significant component in analysis and estimation.
• Strong Cash Generating Ability Supported by Strong EBITDA Margin and
Stable Revenue Growth
Based on the historical 5-year analysis, MSFT has been generating more than 20 billion
unlevered free cash flow per year since 2012, except the recent year 2016. From the
explanation in MSFT’s annual report of 2016, we noted that there was a 6.6 billion
revenue deferral due to Windows 10 update. Excluding the effect from the deferral, MSFT
kept the strong ability in generating cash flows.
• Stable revenue growth
As we can see in Figure 25, its revenue kept an upward trend from 2012 to 2016
(excluding the deferral effect), which is quite impressive given its substantial revenue
base—more than 80 billion on average in recent 3 years.
• Strong EBITDA Margin
In Figure 26, MSFT kept a higher-than-30% EBITDA margin since 2012, and outperformed
peers on both average and median number. In addition, LinkedIn has been increasing in
both revenue and operating cash flow for consecutive 4 years. (Figure 16)
• Low liquidity and solvency risk
The current ratio and quick ratio of MSFT were healthy in past five years, and were above
2.0 on average. Interest coverage ranged from 17.1x to 73.6x. Long-term debt to equity
ratio ranged from 16% to 57%. These ratios indicated that MSFT has a promising position
in both short-term liquidity and long-term solvency.
10. 10
Table 28: Risk Mitigation
Source: Team estimate.
Table 29: ISS Grades
Source: Yahoo! Finance
Investment Risk
Regulatory Risk:
• RR1 Government litigation
Microsoft’s operation is closely scrutinized by government agencies under both US
and foreign countries because of its international business. The specification of laws
in different jurisdiction is often unclear and subject to changes over time. Unstable
regulation may have adverse impact on the company’s operating and earnings
(Figure 27).
• RR2 Cloud computing legal issues.
The legal and regulatory environment for cloud computing services is complicated
and not static. New laws proposed can largely change the responsibilities of both
service providers and cloud services users.
Market Risk:
• MR1 Currency Exchange risk
Most of Microsoft’s revenues and expenses related to international operations are
realized in foreign currencies. In fiscal year 2016, the company’s revenue decreased
9% as compared to fiscal year 2015, primarily due to the strengthening of U.S. dollar
relative to other currencies. Changes in foreign currency exchange rates will
significantly affect Microsoft’s profit margin.
• MR2 Fluctuating PC demand
As the declining global PC market is expected to continue, revenues from Microsoft’s
commercial licensing and D&C licensing are affected had the PC demand gone low
(Figure 28).
Economic Risk:
• ER1 Intense competition
The market for software, cloud-based services, and electronic devices is fluctuating
and becoming more and more competitive. The company’s competitors consist of
large companies like IBM, Oracle and Facebook, as well as local application
developers in Asia, Europe and other countries. Growing competitive pressure may
increase Microsoft’s operating costs hence depress its net income and market share.
Operation Risk:
• OR1 Investment in existing products may not achieve profitability.
Microsoft are still investing in its core business as Windows and Office as well as
emerging business as its searching engine Bing and Surface. Continuing profitability
in these areas may not be assured in future years, unfavorable results will have
negative impact on Microsoft’s total earning.
• OR2 Integration of LinkedIn into Office 365 and Dynamics 365
The acquisition of LinkedIn is supposed to strengthen the revenue for the Productivity
and Business Process segment, which depends on the integration of LinkedIn and
Microsoft’s Office 365 and Dynamics 365. If the integration is done in the right way,
further growth of Microsoft’s Office franchise can benefit the company’s results of
operation, otherwise it may have adverse impact concerning the acquisition cost.
Risk Mitigation
Risks Mitigating factors
Cloud
computing
legal issues
Fully consider of legal
requirements in
different countries and
industry when providing
services.
Currency
exchange risk
Usage of effective
derivatives to hedge
risks.
Fluctuating PC
demand
Change of strategy of
Microsoft reflects the
consideration of
unfavorable demand
fluctuation.
Intense
Competition
Competitors need to
invest significant capital
expenditure to match
the pace of the industry
as well. Microsoft's
increase in profit and
stock price indicates its
ability to compete
among the market.
Profitability
Intelligent cloud
segment which is
expected to achieve high
level of income may
offset the impact.
Institutional Shareholder Service (ISS)
Corporate Governance QuickScore
Board Structure 1
Compensation 3
Audit& Risk Oversight 1
Shareholder Rights 1
