Technology giant Microsoft Corporation (NASDAQ:MSFT) hasn't exactly had a banner year. The stock is up just 1% year to date, as the company has struggled from concerns over declining personal-computer shipments, as well as its poorly performing Nokia handset acquisition. It's also true that global PC shipments are falling, at a disturbing rate, and Microsoft's Windows sales declined significantly last quarter.
But looking ahead, the poor Windows performance was probably an aberration, as consumers and businesses seem to have delayed buying new PCs until the release of Windows 10. This pent-up demand could boost Microsoft's Windows business over the remainder of 2015. And as it pertains to Nokia, Microsoft should be credited with doing what's necessary to resolve the issue once and for all.
For these reasons, the worst may be behind Microsoft.
A quarter to forget
The Nokia writedown got most of the attention when Microsoft reported its most recent quarterly earnings. The company took $8.7 billion in total write-offs last quarter, including $7.5 billion related to the ill-fated Nokia deal. All told, Microsoft reported a massive $3.2 billion loss for the quarter.
If that weren't bad enough, Windows revenue fell 22% last quarter, year over year. This development could scare investors into thinking the decline of the PC threatens one of Microsoft's most important businesses. Indeed, market-research firms Gartner and IDC reported that PC shipments fell 9% and 11%, respectively, in the second quarter, amounting to the steepest quarterly decline in the past two years.
But put differently, investors now have much brighter days ahead. Microsoft can finally put the Nokia mess behind it, and I believe CEO Satya Nadella deserves credit for resolving his predecessor's mess. Going forward, the company can focus its efforts intently on the catalysts that will fuel its future -- namely, further growth in the cloud and the release of Windows 10.
First, Microsoft is enjoying huge growth in its cloud-based businesses, including Office 365, Azure, and Dynamics. In fact, cloud revenue soared 88% last quarter, year over year, or 96% excluding foreign exchange effects, and reached an annualized rate that now exceeds $8 billion. This performance helped Microsoft post core operating results that were not nearly as bad as the headline numbers. Excluding the one-time charges, Microsoft's core earnings per share would have increased 10% last quarter, year over year.
And as it pertains to Windows, the early results for Windows 10 are encouraging. According to The Wall Street Journal, Microsoft said more than 14 million devices were running Windows 10 in the first 24 hours of the new operating system's release. A success here would be huge for Microsoft, since the Windows franchise represents roughly 25% of the company's total revenue.
This point ties into the weak PC shipments I mentioned. It's plausible that consumers, at both the consumer and enterprise level, delayed purchasing new PCs given the impending release of Windows 10. Second-quarter global shipments were obviously weak but could have represented a bottom.
Microsoft is still worth owning
Fundamentally, it appears Microsoft's business is still going strong. The company generated $23 billion of free cash flow in fiscal 2015. The company has done a great job of growing annual free cash flow over the past decade:
It uses a lot of this cash flow to aggressively reward shareholders. Microsoft bought back $14 billion of its own stock in the past fiscal year and paid an additional $9 billion in dividends. Microsoft's dividend yield currently sits at 2.6%, which handily beats the average stock dividend yield of closer to 2%
Microsoft has a great balance sheet, with $108 billion in cash, short-term investments, and long-term investments on the books, up from $100 billion at this point last year. The company also holds a triple-A credit rating from Standard & Poor's.
Therefore, while the declines in Windows revenue and the massive Nokia write-off are discouraging, these headwinds will probably prove temporary. Microsoft remains a very sound business.