Hopes stuck in the Cloud(s)?
News just came out that its cloud service Azure just reached $1 billion in sales, as subscriptions rose 48% over the past 6 months. Forrester Research sees the number of companies using Microsoft’s cloud computing services rising from 20% now to possibly 35% by next year. Amazon.com, Inc. (NASDAQ:AMZN) dominates the market right now, with 71% of all companies currently using cloud computing services, using Amazon.com, Inc. (NASDAQ:AMZN)’s offerings. Amazon has been investing every dollar it makes right back into the business, as they pay out no dividend and don’t aggressively buy back shares.
Amazon.com, Inc. (NASDAQ:AMZN)’s cloud offering has grown like weeds: its customer base has grown by 102% YTD and usage of those services has grown by 50%. It will be hard for Microsoft Corporation (NASDAQ:MSFT) to wedge itself in, but the fact that the company is experiencing high double-digit growth in this relatively new market will help it grow, even if the PC market is “collapsing”.
The cloud is a rapidly growing industry, and both of these players can share in the growth. According to Gartner, the cloud computing industry will grow from $76 billion in 2010 to $210 billion by 2016 (right now it is at $110.3 billion). As the pie grows bigger, both stand to benefit regardless of shifting market share.
Tablets
Another area both these companies compete in is the tablet industry, along with Google Inc (NASDAQ:GOOG) and Apple Inc. (NASDAQ:AAPL) of course. Another report, this one from Strategy Analytics, shows Microsoft Corporation (NASDAQ:MSFT)’s OS with a 7.5% share in the tablet market, up sharply from zero last year.
This means that Microsoft Corporation (NASDAQ:MSFT)’s OS sold 3 million tablets in the first quarter of 2013. Apple sold 19.5 million iPads to take 48% of the market, while Android came in second to sell 17.6 million units to take 43% of the market.
That is for the Operating Systems, but when it comes to manufacturing, Amazon took 3.7% of the market (in the same time period) as Microsoft took 1.8% (per IDC). Microsoft makes more money selling its Surface tablets, but still makes a nice royalty fee off of Windows licenses (around $40).
Google Inc (NASDAQ:GOOG) has been aggressively taking up market share, and in a different study by IDC it has surpassed Apple Inc. (NASDAQ:AAPL)’s iOS in terms of market share. Google’s advantage is that it can sell tablets at a variety of different price points, even below cost, such as with Amazon’s Kindle and Fire, which is hard for Apple, which makes most of its money on the sale of the device. Plus, once it gets that sale, it generates income for a lifetime off of the Google Inc (NASDAQ:GOOG) Store, and advertising revenue from consumers using Google search.
The benefit of this rapidly growing tablet market for Apple Inc. (NASDAQ:AAPL) is that it will help push its margins, as gross margin for the iPad Mini is 40.4%, and 38-39% for the iPad, which is higher than the 35-37% expected for Apple overall. Even if iPhone sales slow down, Apple has its dominance in the tablet market to fall back onto.
Back in Q1 2012, only 18.7 million tablets were sold, which means that there was 117% growth in the market as 40.6 million units were sold in this year’s first quarter. This is down from the 146% year over year growth last year, but shows us that consumers are taking well to the tablet market.
We have yet to see what kind of consumer purchasing cycle tablets will have (such as 2 years for smartphones or 8 years for PC’s), but if tablets can get a 3-4 year cycle in (with hardcore techies buying it every year) then Microsoft has another high-growth market to muscle its way into.
Both of these recent findings have helped push Microsoft’s stock up even more after its latest earnings report, but some major headwinds lay ahead.
The “collapsing” PC market
PC’s are done for; PC’s are obsolete; PC’s are no good; PC’s are last years technology. All of these and more are the slogans of the PC pessimists who think the PC market is over as consumers move to tablets. This is supported by an IDC report saying that PC shipments for Q1 2013 fell 14% year over year versus Q1 2012. Even Apple saw its Mac shipments fall 7.5% (OMG, Apple?!?).
This is considered the harbinger of death for Microsoft, as over half of both its revenue and profit come from its Windows and Office division. But if consumers aren’t buying new computers, corporations are holding off on upgrades, and governments are cash strapped and can’t upgrade as well, then Microsoft can’t grow because its biggest segments (with operating margins around 70%) are holding the rest of it back.
Final thoughts
The tablet and cloud industry are going to be important growth drivers for Microsoft in the years ahead, and both could help reduce Microsoft’s dependence on Windows/Office. The PC market isn’t going to disappear, especially not in a day, so I don’t expect to see Microsoft become obsolete as some ultra-bears contended.
On the other hand, Microsoft Corporation (NASDAQ:MSFT) is trading at a PE (TTM) of 17.2 and is expected to grow around 10% for the next few years, so I would say it is fairly valued. I don’t expect Microsoft’s rally to go to much higher, but $35 a share seems reasonable. The biggest worry for shareholders as to what could push Microsoft back in the $25-$32 range, is if IDC comes out with more double digit drops in PC sales over the next few quarters.
If the PC market gets better or at least sees smaller declines, Microsoft will trend higher. If not, and PC sales continue to slum by double digits in 2013, Microsoft Corporation (NASDAQ:MSFT) will go back to being range bound and could fall by 20-30% to go back into the high $20’s.
Callum Turcan has no position in any stocks mentioned. The Motley Fool recommends Amazon.com, Apple, and Google. The Motley Fool owns shares of Amazon.com, Apple, Google, and Microsoft.
