Microsoft’s win in the Pentagon’s $10 billion JEDI over Amazon’s AWS was only the tip of the competitive iceberg that will only get bigger in 2020
By Matein Khalid: Chief Investment Officer and Partner at Asas Capital
I argued the rationale for a strategic buy call on Microsoft (MSFT) at $100 in a December 2018 software share analysis I published in my media platforms and newspaper columns. Yet even I was stunned by the 57% return Mister Softy generated in 2019, now that MSFT trades $157, though my wife, unimpressed, pointed out that Apple rose 73% in 2019 – she is, as usual, right. Erich Segal said love means never having to say you are sorry but matrimonial bliss requires one to repeat “honey, you are right and I am sorry” LOL!
I cannot disagree with Dan Ives, the finest software analyst in the world I know, that it makes no sense to assume that Microsoft’s spectacular valuation re-rating is over. Of course, I would love to reenter the shares on a market hit that takes Microsoft down to 132 – 134 a share. After all, Wall Street’s interest rate tantrum last December saw Microsoft fall well below 100 and triggered my table pounding, Radio Gaga buy call on MSFT, published while I was on a visit to the lovely, haunted and the exquisite beauty of Cape Town and the suburban calm of Roshni, South Africa. I feel Dan Ives is right and Microsoft could well rerate even more to $185. Why?
Like Amazon in 2014-16, the explosive growth phase of AWS, which now contributes 71% of Jeff Bezos’s operating income, Microsoft’s cloud business is high octane ballast for the next acceleration in its operating earnings and EPS growth. Office 360, LinkedIn, Bing, Xbox and the entire enterprise software product suite is on a roll and Azure is actually winning market share and prestigious cloud deals from Amazon’s AWS.
The revenue growth rate of AWS has decelerated from 80% to 35% in the last five years. Microsoft’s win in the Pentagon’s $10 billion JEDI over Amazon’s AWS was only the tip of the competitive iceberg that will only get bigger in 2020. After all, Microsoft’s Azure is the dominant force in the hybrid cloud architecture that will obsesses the high priests of enterprise software in the next decade.
Wall Street is not pricing the sheer scale of acceleration in the hybrid cloud enterprise segment that Azure rocks even if Amazon AWS remains the global market share leader in the public cloud domain. At a valuation multiple of 29 times earnings, I do not believe Microsoft is remotely overvalued though I would use a correction to sell at the money put options, ideally if implied volatilities in Chicago rise to 25%, as they did in the mini-meltdown of late 2018. With some help from its CBOE options, I expect to trade Microsoft in a 135 – 180 range in 2020.
Even though the S&P 500 index rose by a stellar 26% in 2019, Microsoft rose by more than twice the broad index of Wall Street equities. Satya Nadella is a gift that does not cease giving for me and my friends, one of history’s great money making machines reincarnated as a modest, soft spoken software industry titan.
MSFT’s Intelligent Cloud Division revenues rose by a stunning 27% when the company reported in October. Azure was the crown jewel of Intelligent Cloud, up a phenomenal 59%, but LinkedIn/social media also delivered double digit growth. Options open interest and call buying suggest MSFT is still under accumulation by both real money and hedge fund accounts till at least 170 – 175.
In retrospect, CEO Satya Nadella has executed the most spectacular turnaround in the history of global software since 2013. Microsoft shares rose from 30 to 157 in his tenure, a colossal legacy of wealth creation that I both chronicled in my financial press columns and benefited from in my family investment account.
The corporate culture Nadella has fostered simply makes the Ballmer era “Evil Empire of Redmond” label anachronistic. Microsoft’s workforce is a microcosm of the world (including my South African software maestro bother in law!) and it truly cares for its employees welfare, as illustrated by its $500 million investment in affordable housing in Seattle. I feel proud to buy the shares of a company that creates both shareholder and social value, not destroys them like so many predatory, debt driven businesses in the Gulf with their command and control, quasi feudal, communal, mediocre Stone Age corporate cultures.
Microsoft’s market cap has risen a stunning $860 billion since 2013. Microsoft’s lost decade under Steve Ballmer was a disaster for shareholders and the business. Ballmer missed the social media revolution, surrendered to Google in paid search, was humiliated by Apple and Samsung in smartphones, a strategic disaster that culminated in the acquisition and exit from the Nokia mobile phone joint venture.
Microsoft’s Azure even trailed Amazon’s AWS in cloud computing. Microsoft under Bill Gates and Steve Ballmer just rode the colossal profit wave of its MS/DOS operating system, the (Windows) digital engine of the PC client – server revolution since the early 1990’s. Yet Microsoft is now the king of the hybrid cloud, a pioneer in technology’s most transformational revolutions of our time.