Why Microsoft Corporation Jumped to Fresh 10-Year Highs Today

Microsoft is reportedly about to axe thousands of jobs in a massive round of layoffs. Investors are excited, because Microsoft has its work cut out for it if it hopes to make the Nokia devices acquisition work out favorably.

Jul 16, 2014 at 6:00PM

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Microsoft (NASDAQ:MSFT) is sure having a good year so far, gaining 15% thus far and easily outpacing the S&P 500. Investors are mostly bullish on CEO Satya Nadella's strategic direction, and for good reason. Shares are continuing that momentum today, jumping 2%, to tap fresh 10-year highs.

MSFT Chart

MSFT data by YCharts.

What has Microsoft investors so excited?

The last cut is the deepest (in five years)
Bloomberg reported yesterday that the software giant is preparing to announce a major round of layoffs, the largest in five years. This comes just months after Microsoft closed its acquisition of Nokia's (NYSE:NOK) handset operations. Marketing and engineering positions are likely to be the first to get downsized, according to the report.

After adding almost 30,000 jobs from the Nokia deal, Microsoft's ranks have now swelled to more than 127,000. Microsoft laid off 5,800 workers back in 2009, and the upcoming round could potentially top that figure. A separate report suggested that 1,000 of these job cuts would be in Finland.

It's all part of the plan
Investors are welcoming this move because it will bring Microsoft one step closer to making the Nokia deal work out. When the deal was announced last September, the company estimated that it could realize $600 million in annual cost synergies within 18 months. It's been just three months since closing, and Microsoft is wasting no time at all.

Msft Nok

Source: Microsoft.

That will be key to making the deal accretive to adjusted earnings per share by fiscal 2015, which just officially kicked off this month. By fiscal 2016, Microsoft expects the acquisition to be accretive to GAAP earnings per share, as well.

Microsoft's net present value projections also assume that the company can get handset operations to 5% to 10%. That's a pretty lofty goal relative to the negative 17% operating margin that Nokia's devices business put up just before the deal closed. Microsoft definitely has its work cut out for it, and reducing headcount is a necessary part of the process.

That lack of profitability is why Nokia is emerging from the deal a much stronger company. Not only did it get a major cash infusion, it jettisoned the segment that was dragging on results. Nokia's remaining network equipment business is much more profitable, enjoying a 9% adjusted operating margin last quarter.

Last quarter, Microsoft did a good job of reducing operating expenses by 7%, which was before the Nokia deal closed. With the upcoming earnings release next week, Microsoft's operating expenses will inevitably rise after adding tens of thousands of employees. At the same time, it will likely suffer margin dilution from said unprofitable handset business. Every little bit of cost savings will help.

Can Microsoft compete with the iWatch?
Apple recently recruited a secret-development "dream team" to guarantee its newest smart device was kept hidden from the public for as long as possible. But the secret is out, and some early viewers are claiming its everyday impact could trump the iPod, iPhone, and the iPad. In fact, ABI Research predicts 485 million of this type of device will be sold per year. But one small company makes Apple's gadget possible. And its stock price has nearly unlimited room to run for early in-the-know investors. To be one of them, and see Apple's newest smart gizmo, just click here!

Evan Niu, CFA owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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