AI

Why Microsoft’s cloud business could soon be bigger than Windows

You’d never know it from Microsoft’s (MSFT) press coverage, but as a company, it is kicking butt and showing the path forward for big tech.

The Redmond, Wash., software giant announced last week that Cortana, its digital assistant, is being positioned as an application, not a platform.

Microsoft has already made a big leap into the cloud, one that is already paying off nicely. Now, its future is subscription applications that run everywhere.

Investors should pay attention.

The transition began in 2014. That’s when Satya Nadella, Microsoft’s 49-year-old CEO, started pushing subscriptions and the cloud as the future of the company.

He worked with Red Hat (RHAT) to boost Azure Cloud, the company’s cloud-computing platform. Another deal was struck with Salesforce (CRM) to bring Microsoft Office applications to its giant customer relationship management platform. And Nadella reached out to Amazon.com (AMZN) so Cortana play could play nice with Alexa.

It was a monumental remaking of the business Bill Gates and Steve Ballmer built …

Windows as a platform became secondary. Hardball tactics with competitors were replaced with collaboration.

Critics argue that Microsoft backed into this strategy.

The spectacular failure of Windows Phone and the slow adoption of Cortana as an AI voice platform is evidence Redmond simply could not compete with the likes of Apple (AAPL), Alphabet (GOOGL) and Amazon.

That’s fair. Building platforms is difficult even in the best of times. In the era of big tech, billion-member ecosystems and network effects, the process is almost impossible.

Nadella explained the paradox in a 2017 interview with the editor of GeekWire. Microsoft could not to attract developers without market share, and it could not gain share without applications from developers.

But that does not mean Microsoft is in a position of weakness. Focusing on applications has been transformative for the company.


Today, Microsoft looks more like Adobe (ADBE) and Salesforce, and less like IBM (IBM) or Oracle (ORCL). Its applications are delivered from the cloud, and run smoothly everywhere. Subscriptions generate two-thirds of its revenues, which produce strong cash flows.

Moreover, it has also gotten its Office suite to run well on Apple and Android devices. This has strengthened its productivity leadership in the corporate world.

While Apple suppliers were talking about dwindling demand for iPhones and Alphabet executives were being hit with anti-competition fines in Europe, Microsoft was quietly becoming the most-valuable public company in the world.

Along the way, Microsoft acquired networks. It spent $26.2 billion in 2016 for LinkedIn, a popular social media network for professionals. In 2018, it acquired code-sharing site GitHub for $7.5 billion.

Behind the scenes, Azure continues to grow quickly. Sales at the public and hybrid cloud business surged 76% in the first fiscal quarter of 2019.

Although Microsoft does not break down specific financials for its cloud operation, CNBC reported in December 2018 that sales could reach $26.4 billion through fiscal 2021.

That would make Azure a bigger business than Windows.

Cloud is the foundation for all of Microsoft’s businesses, present and future. Productivity, server, enterprise, advertising and Windows have all moved to the cloud. The company is even building a Netflix-like game-streaming service that will live in the cloud.

It is easy to focus on all the moves Microsoft managers got wrong. But they are getting more right than all their competitors in the service space.

It’s freaky. The company that built Windows is now the biggest player in the open-source developer community.

It makes perfect sense. The new Microsoft is about getting company software to run well on as many platforms as possible.

That focus means applications are as portable as they are ubiquitous. It also means subscribers are loath to leave these services.

With a market cap of $814 billion, Microsoft shares have held up much better than the rest of big technology. And at 21x forward earnings, they trade at a significant premium to its rivals Oracle (13.4x), IBM (9.6x) and Apple (11.3x).

This premium is largely justified. Microsoft has stronger prospects and a more secure stream of future revenues.

If you want to get into, or back into, techs, consider buying Microsoft shares into the next major decline.

Best wishes,
Jon D. Markman

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