Microsoft Q3 – Groundwork

The foundations of something better are being laid.

• Microsoft reported good results as cloud and corporate helped offset the ongoing weakness in PCs.  
• Fiscal Q3 revenues / EPS were $20.4bn / $0.68 compared to consensus at $20.4bn / $0.63.
• Streamlining of OPEX and the transfer of a key campaign from Q3 to Q4 was mostly responsible for the EPS beat.
• The shares are having a relief rally as cloud is managing to offset the ongoing PC weakness while Microsoft gets its house in order.
• On that front I am increasingly confident that Nadella is not going to abandon the consumer assets meaning that this company has a future as an ecosystem provider.
• In fact, it is the only one that is capable of offering both a consumer and an enterprise ecosystem.
• If Microsoft can marry the two in a way that works it will be the only offering that run the Digital Life of a user at work as well as at home.
• They key to this will be integration.
• Microsoft needs to be able to identify a user across all of its Digital Life services not just maintain a discrete user database for every service.
• Right now all of the different services sit in glorious isolation within their respective ivory towers and their integration represents one of the biggest challenges that Nadella faces.
• This is essential to get the most value from Digital Life service both in terms of quality of service and monetisation.
• So far only Google (and to some degree Apple) have achieved this.
• Microsoft still has a lot of work to do but it seems that Nadella has decided to take the harder road to turn Microsoft into a real ecosystem company.
• This gives much greater upside in terms of long term revenue growth but the execution risks are much greater.
• In the last few weeks Nadella has made moves that would have been impossible a few years ago (Office in iPad, Windows for free) and this gives me hope that Microsoft can change.
• A steady set of Q3 results and guidance lays the groundwork for a different company to emerge from under the skin of the old.
• Microsoft remains attractively priced given the opportunity and execution risk that lie before it.