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Microsoft Shifting Gears on All Fronts

Posted on Thursday, May 11th 2017

Last year, I had suggested that Microsoft (Nasdaq: MSFT) may well be a dark horse in the five horse tech race. Its recent performance confirms that analogy. And the horse is running a good race. The company continues to compete with the likes of Apple, Amazon, and Alphabet across multiple offerings to make sure it no longer lags.

Microsoft’s Financials

Microsoft’s Q2 adjusted non-GAAP revenues grew 8% over the year to $23.6 billion, marginally ahead of the market’s forecast of $23.62 billion. EPS of $0.73 was also ahead of the Street’s expectations of $0.70 for the quarter.

By segment, revenues from the Productivity and Business Processes grew 22% to $8 billion driven by a 7% growth in revenues from Office commercial products and cloud services. Within the segment, Office consumer products and cloud services revenue increased 15% and Office 365 consumer subscribers increased to 26.2 million. Dynamics products and cloud services revenue increased 10% and LinkedIn brought in $975 million in revenues.

Revenue from Intelligent Cloud grew 11% to $6.8 billion mainly due to 15% increase in Server products and cloud services revenue, which was driven by 93% growth in Azure revenue. Enterprise Services revenue fell 1% due to reduction in custom support agreements.

Revenue from More Personal Computing fell 7% over the year to $8.8 billion due to lower phone revenue, primarily due to a 26% reduction in Surface revenues. Within the segment, Windows OEM revenue increased 5% and Windows commercial products and cloud services revenue increased 6%.

Microsoft Ready to Face Competition

Microsoft is stepping up gears to compete with the other big tech players across multiple segments. It has been working on a new speaker Invoke in partnership with Harman Kardon. Invoke has the Cortana voice assistant installed and will help Microsoft compete with Amazon Echo and Google Home. It is expected to be available in the market in the fall of this year. This is the first standalone product that Microsoft is selling that provides access to Cortana. Unlike its competitive offerings, Invoke comes with Skype built in so that users can call cellphones and other Skype users directly from the device. Back in March last year, Skype had recorded over 300 million users. The idea of integrating Skype into Invoke is an interesting strategy for market penetration.

Even so, Invoke has a long way to go. Microsoft will need help from developers to build a smart home product that will be able to work with the apps and services do things like control home temperatures and help with search. To help with the development, Microsoft will hold a Build session to help implement voice-first and voice-only experiences using the Cortana Skills Kit. Amazon had opened Alexa to developers two years ago and already has over 10,000 skills available.

To further compete with Alphabet, it recently announced a suite of new products and services focused on teachers and students. Microsoft is the leader in the installed educational base, but with the release of Google Chromebooks and G Suite, Alphabet has become a product of choice in the K-12 segment. Within the high school and College students, Apple MacBooks are a preferred product. To try to win this market back, Microsoft announced the launch of Windows 10 S which will feature additional security, safety, and speed needed for educational settings. All applications in Windows 10 S will be downloaded from the Windows Store and then run locally within a secure container to provide consistency in performance while ensuring higher security and privacy. I am not convinced about this strategy.

It has also upgraded its browser Microsoft Edge. It will now feature a new Tab Preview Bar and a scribble note pad directly on a web page that can be saved and shared. Like its other moves, this is another bold one that will need significant effort to deliver.

To take on Apple, it launched a new Surface Laptop. Microsoft may have released the new Surface as part of the new suite of products for the education segment, but at $999 apiece, it is a significantly expensive Chromebook for students. Several believe that the new Surface is targeted more at Apple’s Macbooks. The new laptop will work on Windows 10 S, but consumers will have the option of switching to the Windows 10 Pro by paying a one-time $49 upgrade fee. The new Surface runs on Intel’s Core i5 or Core i7 processors.

Finally, to up the competition with Amazon it has continued the development of its cloud offerings. Recently it announced a joint offering with Dell EMC, the Dell EMC Cloud for Microsoft Azure Stack. The service will help accelerate the process of deploying and managing a hybrid cloud strategy for organizations. The Dell EMC integration will offer automated delivery of IT services for both cloud-native and traditional applications and help integrate user experience across the Azure public cloud environment and the Azure Stack private cloud. Microsoft is also working on making Azure a particularly convenient platform for Artificial Intelligence developers. This initiative isn’t quite ready for the mainstream market yet, but I recently spoke with Josh Sutton at Sapiens who talked about the progress in their efforts. Earlier, I had spoken with Mark Russinovich, CTO of Azure, who shared with me Microsoft’s plans along these lines.

I still think that Microsoft will benefit by making a few acquisitions within cloud services in the application layer in the next couple of years. There are plenty of cloud-based enterprise offerings for Microsoft to choose from. For instance, there is the analytics offering of Tableau that would help add impressive visualization capabilities to its Power BI tool. For enterprise workflow offerings, it can evaluate the acquisition of Workday and ServiceNow. Then, there is Splunk which will help Microsoft improve its machine-to-machine analytics capability. There are also numerous smaller, less expensive SaaS vendors that can offer very interesting trend coverage in their cloud portfolio.

Its stock is currently trading at record high levels of $69.71 with a market capitalization of $538 billion. It had fallen to a 52-week low of $48.04 in June last year. Microsoft ended the recent quarter with cash and cash equivalents of $126 billion – more than enough cash to pick up the cloud offerings I have suggested.

Overall, Satya Nadella has achieved at Microsoft an incredible degree of movement in the right direction.

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