Two iconic technology companies, Cisco Systems (CSCO -0.04%) and Microsoft (MSFT 0.47%), are in the midst of the next wave of tech disruption. Cloud computing, artificial intelligence, and the Internet of Things (IoT) all promise substantial transformation in our technology infrastructure over the next few years.
But these tech titans are also in the midst of a pandemic. Does that change the trajectory for either company? Is one more likely to emerge stronger? Let's look at each to determine the better investment.
Cisco, the leader in computer networking hardware, is contending with a shift in its business model as it deals with the pandemic. The company is transitioning to sell more software and subscription-based offerings, the popular software-as-a-service (SaaS) model, to generate reliable, recurring revenue streams. The transition is going well. In its latest earnings report, for the third quarter ended April 25, the percent of revenue derived from SaaS rose to 74% from 65% a year ago.
But the pandemic affected Cisco's supply chain and caused total product orders to drop 5% year over year. Its core networking business, under its infrastructure platforms division, saw revenue decline 15% year-over-year in the third quarter. As a result, total revenue decreased 8% year over year to $12 billion.
Beyond the pandemic, there's upside for Cisco. Along with a shift to SaaS, another revenue driver is the IoT market. As more devices become internet-enabled, the demand for Cisco's networking products increases.
Billions of new devices, from thermostats to light bulbs, are forecast to go online in the coming years as industries such as manufacturing, public transportation, and automotive increasingly adopt IoT technology to create business efficiencies and deliver new services, such as self-driving cars. The IoT market is forecast to grow to $1.1 trillion by 2026.
These devices will also require a secure network and scalable IT monitoring solutions to allow organizations to manage this device proliferation. As a result, Cisco's security products experienced a 6% year-over-year Q3 revenue increase, and both its AppDynamics monitoring platform and IoT software saw double-digit growth.
Add to this Cisco's strong balance sheet, with total assets of $91.4 billion versus $55.7 billion in total liabilities, and cash and investments of $28.6 billion at the end of last quarter. Its payout ratio of 57% means the company can continue to support its dividend.
Microsoft has enjoyed success under CEO Satya Nadella as the company shifted its focus to cloud computing. In its fiscal third quarter, ended March 31, Microsoft revenue rose 15% year over year to $35 billion, and the company stated "COVID-19 had minimal net impact on the total company revenue."
Microsoft's cloud technology is powering the business infrastructure for companies such as Coca-Cola, which signed a five-year agreement with Microsoft in April. The company's core cloud platform is called Azure, and it's proving Microsoft's success in the cloud market with impressive year-over-year revenue growth of 59% in Q3.
That's just the beginning. Microsoft is also investing in the IoT. Last year, the company acquired Express Logic, which provides the operating system for IoT devices. Recently, Microsoft added CyberX, a company specializing in security for IoT devices, to its list of acquisitions.
Another investment area is artificial intelligence (AI). The AI market is projected to grow at a compound annual rate of 46% between 2019 and 2025, reaching global revenue of $390.9 billion by 2025. Because IoT and cloud computing involve large amounts of data, AI must be leveraged to make sense of and use the data in business applications. Consequently, Microsoft is investing to build out AI capabilities in Azure.
Microsoft also enjoys a strong balance sheet. At the end of last quarter, total assets were $285.4 billion compared to total liabilities of $170.9 billion, while cash and short-term investments were $137.6 billion. With a low payout ratio of 34%, Microsoft's dividend is secure.
The final verdict
Microsoft's business is firing on all cylinders, and the pandemic isn't hurting revenue so far. While Cisco is the industry leader in its space, Microsoft has a far larger market from which to draw customers, which includes the consumer market through its Xbox gaming division.
Microsoft doesn't have to be the leader in cloud computing or the other growing technology trends and it can still capture significant revenue growth. These strengths make Microsoft the better buy in this matchup.