Microsoft (MSFT): Less Bad than Expected

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Microsoft  (MSFT):  Less Bad than Expected

Rating  UNDERPERFORM Price Target $38.00 Price $43.34

Key Takeaway MSFT's results were not as bad as feared, but pretty bad nevertheless, though the stock movement after hours indicates that the market sees “less bad” as “good”. Revenue/EPS were both better than guidance, which established consensus, but revenue was better due to more than expected transactional business and still only flat from a year ago (ex. acquired phone revenue), while earnings declined 11%. Guidance for revenue and implied EPS were both below consensus. Details. EPS of $0.61 on total revenue of $21.729B were both better than consensus estimates of $0.53 and $21.074B, respectively. June guidance for both EPS (implied at about $0.55-$0.58) and revenue ($21.6-22.3B) were below consensus estimates of $0.61 and $22.748B, respectively. What do F3Q numbers mean? They reflect that about 40% of revenue and 80% of profit is tied to the PC ecosystem. Much promoted “expense control” seems to be a perception game, since expenses have been increasing less than guidance, but increasing nevertheless. Unearned Revenue was less than expected due to greater transactional mix, which inflated revenue by at least $1B. What does F4Q guidance imply? This will be the first quarter where phone was present in each period, and total revenue is expected to decline 5-8%. It also implies the first time since the recession in 2009 that operating expenses will actually decline. And then there’s Cloud. We understand the logic and benefits to Microsoft for moving its business in this direction, but we also believe there is ample risk that investors should not underestimate. We continue to rate MSFT Underperform with a $38 price target based on our DCF. Valuation/Risks PT of $38 is based on an equal weighting to our 5 DCF scenarios. Key risks include the PC cycle and risks to margins and revenue as MSFT transitions to the Cloud