Laptop running Windows 10. Source: Microsoft
After an exceptionally strong fiscal first quarter earnings report, Microsoft (MSFT +2.11%) shares are trading near a 15-year high. Demand for Microsoft cloud services remains strong, and its latest operating system -- Windows 10 -- is off to an impressive start. Microsoft appears to be successfully transitioning into hardware, and its investment in search is finally paying off.
Could Microsoft shares be headed even higher? A general market downturn could always take a toll, but if the following scenarios come to pass, Microsoft could soon be headed to new all-time highs.
Surface revenue surges
Microsoft's Surface business has come a long way in recent quarters. After initially looking like an outright failure, Surface sales broke the $1 billion mark late last year.
This quarter, Surface-related revenue actually fell, dropping to $672 million from $888 million in the June quarter. Yet that doesn't reflect too poorly on the business or Microsoft's larger hardware ambitions. The company released the Surface Pro 3 in June 2014 -- a refresh was widely anticipated. The recently launched Surface Pro 4 and Surface Book weren't included in Microsoft's most recent report, but strong demand for both products should boost Microsoft's Surface sales in the quarters to come. The Surface Book quickly sold out and remains back-ordered. At upwards of $1,500, it's not for everyone, but it gives Microsoft a competitive Windows offering to entice Mac users.
Microsoft doesn't break out Surface earnings directly, but it has said the Surface achieved profitability last year (on a gross margin basis). Given its high-end positioning, the Surface business could be a solid source of earnings if Microsoft can continue to grow sales.
Bing could take a larger share of the search market
Microsoft's most recent quarter was a historic one for its search engine, Bing. Unfortunately for shareholders, Bing has been a source of red ink for most of its history -- but it finally achieved profitability in Microsoft's fiscal first quarter.
That turn in fortune is likely attributable to the success of Windows 10, as Bing is deeply integrated with Microsoft's latest operating system. Bing powers Microsoft's digital personal assistant, Cortana, which is built into the Windows 10 taskbar and browser. Windows 10 has enjoyed a robust rate of adoption and now powers over 110 million devices.
Bing's share of the U.S. search market rose to 20.7%, up from about 18% two years ago, and its advertising revenue rose 29%. During Microsoft's earnings call, CEO Satya Nadella credited Windows 10 adoption for Bing's gains, and Microsoft expects that momentum to continue.
As more users upgrade to Windows 10, and Cortana makes its way to more devices (not just Windows but also Android and iOS), Microsoft's share of the search market could continue to increase, and Bing's profitability could rise further.
Office 365's new plan enjoys robust enterprise adoption
This quarter, Microsoft plans to roll out a new version of Office 365, its subscription-based productivity cloud service. Office 365 E5 is a new high-end offering aimed at enterprise customers. It includes the traditional productivity software businesses expect, along with communication and analytic tools, but also brings Microsoft into the realm of security software.
In July, Nadella declared that Office 365 E5 would become one of the biggest drivers of Microsoft's business, adding an additional market opportunity of $50 billion. On Microsoft's most recent earnings call, CFO Amy Hood hinted that it would be a higher-margin service, given its premium pricing.
Microsoft expects its commercial cloud services to generate $20 billion on an annual basis by 2018, up from over $8.2 billion today. Office 365 E5 could play a key role in ensuring Microsoft achieves that goal.
