Wedgewood Partners, a St. Louis, Missouri-based investment management firm, released its Q1 2020 Investor letter – a copy of which is available for download here. Wedgewood Partners returned -16.30% for the first quarter. Meanwhile, the benchmark Russell 1000 Growth Index and the S&P 500 Index lost 14.10% and 19.60%, respectively.
In the said letter, Wedgewood Partners highlighted a few stocks and Microsoft Corp (NASDAQ:MSFT) is one of them. Microsoft is a multinational technology company based in Washington. Year-to-date, MSFT stock gained 13.3% and on April 29th it had a closing price of $177.43. Its market cap is of $1.36 trillion. Here is what Wedgewood Partners said:
“We initiated a new position in Microsoft during the quarter. Microsoft’s sprawling software and services portfolio has sustainable competitive advantages and durable longterm growth prospects, combined with more reasonable valuation as the stock has sold off from its all-time highs due to COVID-19 disruptions. Although the Company ended the quarter at a +9% weighting in the Russell 1000 Growth Index benchmark, we still believe Microsoft is a worthy destination for our clients’ portfolios on an absolute basis.
Microsoft has a formidable position in productivity software, with between 80% and 90% market share, thanks to the multi decade dominance of Microsoft Office in both commercial and personal end markets. Over the past several years, a substantial portion of the Officeinstalled base has converted from perpetual licenses to subscriptions, yet a still meaningful amount of Microsoft Office revenue remains on perpetual terms. We estimate Office 365 subscriptions could generate a two to three times uplift in revenue per user and add an incremental $20 billion in revenue if Microsoft can manage to phase out perpetual licenses over the next several years. In addition, with a cloud-based delivery model, the Company can quickly develop and add new products and services to the Office 365 suite and monetize by adding higher pricing tiers – rather than waiting years at a time for a new product cycle for on-prem deployments. Microsoft’s newfound ability to quickly develop products, helps maintain its position in the productivity market, despite smaller, fast moving competitors. For example, Microsoft Teams is the Company’s business communication platform that was developed internally over the past few years and officially launched in 2017. Teams has already amassed over 44 million active users to date, with 12 million of those users joining in just the past few weeks, as they seek workfrom-home solutions. Microsoft’s ability to develop and deploy quickly should allow the Company to continue to be in the right place at the right time.
Microsoft has done an excellent job entrenching its position as a mission-critical provider of infrastructure software and services, especially with its Azure cloud platform. Businesses continue to move more workloads onto infrastructure as a service (IaaS) platforms, as IaaS enables more IT flexibility and has lower capital commitments, relative to on-premises hardware and perpetual licenses. Large IaaS offerings, such as Azure, also enable smaller, more sophisticated startups to be more productive, without having to maintain expensive hardware and maintenance headcount. We estimate both on-prem and new market opportunities should continue to drive healthy growth at Azure, where we expect revenues could triple over the next 5 years to between $30 billion and $40 billion, while also displaying substantially better profitability with that scale.
Last, Microsoft’s on-prem Windows server and PC businesses continue to be cash cows that have managed to grow, we estimate, at “GDP”-type rates. While these business lines do not have the secular tailwinds of cloud-based solutions, they continue to be critical investments for on-prem customers and increasingly popular hybrid IT customers. Importantly these customers represent a large installed base that Microsoft can cross-sell existing cloudbased offerings.
We initiated positions in Microsoft after the stock sold off due to a cautious update to its guidance for its Windows OEM business driven by supply chain disruptions in China related to the COVID-19 outbreak. We sold shares in Fastenal to fund the Microsoft purchase, as both have held up similarly well since the market peaked in mid-February. Both maintain similar forward earnings multiples in the low twenties. However, Microsoft has decidedly more Company-specific growth drivers that can offset the inevitable macroeconomic headwinds that the manufacturing sector will throw at Fastenal after the collapse in oil (which was somewhat unrelated to COVID-19). We will look to continue to add to our Microsoft positions as opportunities present themselves in this volatile environment.”
In Q4 2019, the number of bullish hedge fund positions on MSFT stock decreased by about 1% from the previous quarter (see the chart here).
Disclosure: None. This article is originally published at Insider Monkey.
