How Risky Is Microsoft?

Summary New reporting segments give a much clearer view of #Microsoft 's numbers. As certain parts of its business grow, transparency has been on the rise. What do the numbers tell us about Microsoft's risk level as a long-term investment? What’s the risk level with Microsoft (MSFT), and what does the ever-increasing transparency of the company’s reported numbers reveal about growth potential? In this article, we’ll dive into some of its key metrics and take a look at what makes Microsoft such a sound long-term investment. When Microsoft announced its new financial segmentation standards in late 2015, the company decided to throw all its ‘difficult’ products into one segment: More Personal Computing. It served two purposes for the company: it allowed investors to have a clear look at the growing parts of the cloud business, while also showing how it was slowly weaning itself away from Windows revenue. Since then, the company has been very smartly increasing the transparency of its numbers. The higher their growth rates, the more transparent they become. After keeping the real numbers behind Office 365 under wraps for a long time, Microsoft CEO Satya Nadella finally let the world know during the third-quarter 2017 earnings call that the enterprise Software as a Service product has more than 100 million monthly active users around the world, a huge number for a subscription product. Now, during the fourth quarter, the company has made it easier for analysts like us to decipher the numbers behind the More Personal Computing segment and, more importantly, how much money the company makes from Windows. Excerpts from the fourth-quarter earnings release: Revenue decreased $140 million or 2%, driven by lower revenue from Devices, offset in part by higher revenue from Windows, Search advertising, and Gaming. Windows revenue increased $103 million or 2%, mainly due to higher revenue from Windows Commercial and Windows OEM.” - Microsoft Q4 2017 Press Release  Source: Microsoft Q4-2017 Press Release Advertisement   Source: More Personal Computing breakup calculated using growth percentages provided by Microsoft in Q4-2017 Release, as explained below: Windows revenue increased by 2% or $103 million during the fourth quarter of 2017, which means total revenue from Windows was approximately $5,161 million. Search Advertising revenue increased by 8% or $124 million, which means total revenue from Search was approximately $1,550 million. Gaming revenue increased by 3% or $44 million, which means total revenue from Gaming was approximately $1,469 million. Surface revenue declined by 2% or $20 million, which means total revenue from Surface was approximately $1,000 million. Phone revenue declined by $360 million. The More Personal Computing segment has been a stubborn headache for Microsoft, and I don’t expect that to change any time soon. Segment revenue has now declined from $43,160 million in fiscal 2015, to $40,460 million in 2016, to $38,773 million in 2017. That represents a decline of nearly 10% over a two-year period. With Windows contributing nearly 60% of this segment's revenue, it will swing up and down depending on Windows’ performance for the given quarter. And the future for Windows, the dominant operating system in the personal computer world, is bleak at best.  PC sales have steadily declined over the past five years and are still declining. Worldwide PC shipments totaled 61.1 million units in the second quarter of 2017, a 4.3 percent decline from the second quarter of 2016, according to preliminary results by Gartner, Inc.” Both Facebook (FB) and Google (GOOG) (GOOGL) have been reporting steady increases in mobile viewership and mobile search traffic, a clear indication that the shift to mobile is still ongoing and that a reversal to PCs is never going to happen. Mobile advertising revenue represented approximately 87% of advertising revenue for the second quarter of 2017, up from approximately 84% of advertising revenue in the second quarter of 2016.” - Facebook Q2-2017 Press Release Revenues were $25.8 billion up 21% year-over-year. In terms of the revenue detail, Google sites revenues were $18.4 billion in the quarter up 20% year-over-year. The biggest contributors to growth again this quarter were mobile search and YouTube.” - Ruth Porat, Alphabet CFO Q2-2017 Earnings Call Investment Case The bad news for Microsoft investors is that the drop in Windows revenue is far from over. But the good news is that we now know exactly how much of an impact that will have on Microsoft’s overall revenue growth over the next several years. With quarterly revenues just above the $5-billion mark, Windows revenue is still sizable. But when you factor in Microsoft’s overall cloud revenue run rate, which was more than $18.9 billion at the end of the fourth quarter of 2017, it equates to quarterly revenues of around $4.72 billion. What does that mean for the stock? In the next four quarters - and most probably as early as during the first half of 2018 - Microsoft’s cloud services should overtake Windows to become the number one revenue earner for Microsoft, completing the company’s turnaround. The reason that matters is that the further Microsoft’s cloud revenues grow and Windows revenues decline, the faster overall revenue growth will be. And that means steady support for the stock for the foreseeable future. As such, the numbers clearly show that Microsoft carries a relatively low risk factor when compared to high-growth companies like Facebook or Netflix (NASDAQ:NFLX). As the cloud industry matures, Microsoft’s growth will be further fortified by its deep foray into the enterprise segment, and that segment represents longevity, if nothing else. It’s what kept Windows alive for so long, and it’s what will keep Microsoft’s cloud services growing strongly over many more years to come. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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