Last month, Microsoft (NASDAQ:MSFT) announced that it will acquire Equivio, a text analytics company that uses machine-learning techniques to identify relevant documents for legal and compliance needs. Microsoft plans to integrate Equivio's technology with Office 365, which could provide a boost in adoption of Microsoft's cloud-based productivity suite.
Microsoft has been working to convert enterprise customers from its license-based software to its subscription-based Office 365, but the vast majority of customers still install Office the old-fashioned way. Microsoft has slowly been adding features to Office 365 to make it more enticing, but Equivio's technology may be able to provide enough value to convert more users.
Why Equivio fits into Office 365
Equivio's main product line, Zoom, helps businesses manage their documents by sorting them into themes, grouping near-duplicates, isolating unique data, and helping users quickly identify the documents they need. The last feature is especially useful in legal cases and compliance investigations, which is something that just about every enterprise ought to be prepared for.
In the event that a company does face a legal issue, it would take a large number of work hours to go through the huge amounts of data that enterprises produce today. Conversely, that company could license Equivio's software to do the job for it, providing more accurate and efficient results than keyword searches and manual review. And once Microsoft integrates with Office 365, enterprises that subscribe to the service won't even have to worry about it. It's built in.
While Microsoft already has e-discovery and information governance capabilities built into Office 365, Equivio provides a best-in-class service and is court approved. In Microsoft's announcement, the VP of Outlook and Office 365 noted that Equivio will make Office 365's e-discovery tools "even more intelligent and easy to use in the months ahead."
It's all about lifetime value
Microsoft sees Office 365 as an opportunity to increase the lifetime value of its customers. While Commercial Office revenue declined about 1% last quarter as more businesses transitioned to Office 365, Microsoft will be able to extract more revenue from businesses that use its cloud service in the future.
"As you move Office [to Office 365], it's simply the first step," CFO Amy Hood said on the company's second-quarter conference call. "So even though obviously it comes at a little lower gross margin percentage, our ability to add workloads, add premium services, and increase our overall footprint inside a customer is really where the lifetime value goes up." CEO Satya Nadella explained that one result is that more businesses are using its servers because Office 365 includes products such as Exchange and Lync, which are valuable in combination with a server.
Even if Microsoft is seeing its Commercial Office revenue decline, investors shouldn't worry that its biggest cash cow is falling apart. That's part of the design with Office 365. Make the ubiquitous productivity software extremely attractive, and that makes it easier to upsell customers on its other cloud products. Overall, Microsoft believes that an Office 365 subscriber will generate 50% more gross profit dollars than a licensee.
Revenue at Microsoft continues to climb, increasing 8% last quarter. Total Commercial revenue, in particular, increased 4.6% year over year, indicating the cloud-based strategy is offsetting declines in Office revenue.
Equivio is a relatively inexpensive way ($100 million to $200 million) to add some excellent value to Office 365 and continue converting traditional Commercial Office customers to Office 365 subscribers. The long-term value for those customers is greater, and the subscription-based revenue provides more predictable and consistent cash flow for Microsoft.
Adam Levy owns shares of Apple. The Motley Fool recommends Apple and owns shares of Apple and Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools don't 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.