Windows Into the Cloud

There's a lot of negativity and uncertainty surrounding Microsoft  (NASDAQ: MSFT  )  lately. With Steve Ballmer retiring, a new CEO has yet to be announced. Declining PC sales are often associated with a decline in Windows sales. Surface tablet sales last quarter were terrible. Push past all of the noise, however, and you might see the current opportunity being presented to more value-oriented investors.

Microsoft's bread-and-butter
Microsoft's main money-makers are its Office products and its Windows operating system. As of May, the company disclosed that it sold more than 100 million Windows 8 licenses. The new Windows 8.1 update was created to address user concerns with Windows 8, and brings back the much-missed "start" button.

The Windows OS still dominates, with over 90% market share worldwide, as of August. Windows 8.1 was just released this month, and it is too early to judge its success or failure, but with support for Windows XP (roughly 33% of existing Windows users) ending in 2014, there will likely be a big refresh cycle coming from enterprise customers.

Microsoft's new Office 365 is unlike previous versions of the software because it is offered as a subscription service and integrates with the cloud. This new version is also now at a $1.5 billion annual revenue run rate and growing. Other versions of Office also still have a huge moat, with the closest, distant competitor being Google Docs.

Source: Forrester Research,

An enterprise alliance
Back in June, Oracle  (NYSE: ORCL  ) announced an alliance that allows Microsoft's Azure cloud to run Oracle's database software, as well as its Java programming tools and middleware. The alliance will also further attract enterprise customers because of increased compatibility between both companies' products and services. Besides supporting its online software to run on Azure, Oracle will also use Microsoft's Hyper-V virtualization software that allows servers to run more efficiently.

As of 2012, the worldwide database market reached $28.2 billion, with Oracle owning a 45% share. Microsoft owned roughly 20%. The two companies will still compete in the database space, but will also control most of the market by merging customer bases.

Oracle also announced a deal with Salesforce.com around the same time, and it's becoming increasingly clear that the company is making nice with former rivals to move its software and services to a cloud-based subscription model. Its first cloud-based database software, called 12c, was released in July and is pivotal in assisting the company's transition into the future. Oracle shares are currently trading at a cheap 14 times earnings and yielding 1.50%. 

Amazon is still on top
While Oracle is using Azure for its online software, and Microsoft's cloud offering is stronger because of it, Amazon  (NASDAQ: AMZN  ) continues to dominate. Microsoft recently announced its plans for a "government cloud," while Amazon was winning a $600 million, four year contract with the CIA.

The company doesn't break out its cloud revenue, but the recent CIA contract is indicative of its huge growth prospects. According to the Seattle Times, "AWS generates roughly $3 billion in annual revenue, according to analyst estimates, by offering services to businesses at a fraction of what it would cost if those businesses owned and ran their own computers." 

Price wars brought to the cloud
Amazon's low-cost business model has also affected Azure. Microsoft recently announced that it will be discounting its cloud services in an effort to better compete with Amazon. While there is room for more than one player in any industry, Microsoft is a distant No. 2. Considering its dominance in enterprise, however, it will likely continue to expand its share, especially when businesses update and start adopting cloud and subscription-based software like Office 365, which will provide recurring revenue. 

Amazon currently trades at negative earnings without offering a dividend, but its impressive revenue growth has attracted investors, pushing the share price into the triple digits. This revenue will increase with continued expansion of the company's cloud offerings. Monetizing its cloud services will also give the company better prospects going forward if margins increase and give a boost to earnings. The CIA contract also gives it credibility. AWS will be a huge growth driver for the company going forward.

The bottom line
Microsoft won't be as reliant on the PC going forward if it continues on its current trajectory. Despite negative sentiment related to declining PC sales, Microsoft is aggressively pushing into the cloud with Azure. It's also taking its bread-and-butter legacy products, like Office, with it. This should help convert current moats to the cloud, especially with an increasing expansion into mobile. The company is incredibly strong financially, with around $60 billion in cash net-of-debt and AAA-rated credit. Shares offer significant value at current levels, trading at just 13.5 times earnings and yielding over 3%. 

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