Morgan Stanley's Deep Dive Analysis of Microsoft (MSFT): Current Multiple an Attractive Entry Point For a Top Secular Grower

Morgan Stanley analyst Keith Weiss believes the current 26X CY22e P/E multiple offers an attractive entry point for a stock like Microsoft (NASDAQ: MSFT) - a top secular grower.

She weighs in on concerns that the best days are behind Microsoft. In this space, investors’ concerns are centered around 3 key topics: 1) Durability of revenue growth at scale, 2) Potential for further margin expansion and 3) Durability of the multiple if EPS growth slows.

“Over the past three years (CY17 to CY20), Microsoft has added $51 billion in revenues, sustaining a 14% revenue CAGR. Most of this growth was organic, with Azure representing the biggest contributor (+$19.3 billion), followed by Office Commercial (+$9.1 billion) and Gaming (+$4.5 billion). Our forecasts look for Microsoft to sustain a 14% CAGR through CY23, adding an additional $74 billion in revenue run rate,” Weiss says in a research note sent to clients today.

The question that some investors are asking is does Microsoft have the solutions and market opportunity to add those dollars? According to Weiss, the answer is yes.

“Microsoft has consistently proven successful in entering new markets: Security (reached $10 billion revenues growing 40% YoY), Low/no-code (Power Platform MAUs reached 16M, +97% YoY), and SaaS-based apps centered around Office/Teams (145M DAUs nearly doubling YoY), Dynamics, and LinkedIn (756M members).”

Azure, in particular, is expected to act as a key growth engine going forward.

“Capabilities around machine learning, data management, networking, etc.. within the Azure platform create a solid technology foundation for rapidly building out new solutions to enter these new markets,” adds Weiss.

“We forecast a >40% CAGR through FY23. Commentary from the channel points towards continued cloud strength, with previously signed Azure deals, the Microsoft 365 motion, and an enhanced focus on security helping both the consumption and seat-based Azure revenue streams. Our primary research points to an attractive path going forward, as evidenced by CIOs'view that Microsoft should gain the most IT wallet share with the move to the cloud. More specifically, CIOs see Microsoft as the preferred vendor across hybrid cloud, IaaS, and PaaS workloads.”

In addition to Azure, which acts as a key pillar for sustainable growth going forward, Microsoft Office offers an expanding user base and adoption of higher-level functionality to sustain growth.

“At this stage in O365 transition, we see the F1 SKU is driving high single digit installed base growth. On ARPU, our CIO survey suggests further room for attach of the premium O365 SKUs as customers solve for security, video, and telephony use cases. More broadly, O365 only becomes more compelling with Teams as the keystone of workplace productivity,” Weiss stresses.

Elsewhere, MSFT server products have a durable runway of opportunity remaining as companies upgrade to premium stock keeping units (SKUs) and Microsoft enjoys market share gains.

On the gaming front, some analysts have urged MSFT to add bigger names to its portfolio if it wants to hurt Sony’s market share in a more meaningful manner. In this space, Weiss comments:

“Over the years, we have written extensively on Microsoft's strong position within gaming, enabled by its three C's of gaming strategy: Content – best evidenced by the $7.5 billion acquisition of

ZeniMax / Bethesda, Community – 100 million+ Xbox live MAUs and 18 million Game Pass subscribers, and Cloud – Azure + PlayFab. Going forward, we think Game Pass only becomes more compelling as Microsoft continues to amplify the existing gaming catalog, and longer-term the higher-margin, recurring Gaming revenues should help offset margin pressures from hardware, particularly as the mix of gaming revenues continues to shift away from console sales.”

On the financial side of the business, Weiss highlights that cloud gross margins are now higher than overall company margins, which will actually help lift overall margins.

“We expect to see an acceleration in opex growth in FY22 and FY23, due in part to moving beyond the cost savings from limited travel and events in CY20/FY21 and in part due to new market opportunities. Ultimately, we expect to see a return on increased investments, as increased opex will support a more durable double-digit top-line, driving operating margins to ~44% in FY23 from ~37% in FY20. CEO Satya Nadella illustrated this view on the last earnings conference call: "...we are in many more new categories; and in those categories with significant differentiation. So when we think about OpEx, it's not about adding OpEx to the stuff that we had in the past, there's leverage there. In fact, it's OpEx going into new TAMs.”

On the EPS front, the growth is still robust. Weiss calculates that 14% revenue CAGR and expanding margins translates into 21% operating income CAGR. This is not priced-in at current levels, she notes.

As far as the M&A front is concerned, the company could make further acquisitions to grow its business. Recently, the company acquired ZeniMax Media for $7.5 billion and for ~$20 billion, respectively.

“While we have no knowledge of any future transactions, we think M&A is a positive, as Microsoft's large cash balance does little to boost shareholder value. Additionally, we see Microsoft an optimal owner for many different types of assets, given the company's ability to leverage its 1) large existing customer base, 2) expansive user bases across assets like LinkedIn, GitHub, Office 365/Teams, 3) Azure cloud and data platform, 4) vast global distribution channels, all to accelerate top-line prospects while making assets more efficient under Microsoft ownership.”

Overall, the current multiple is still not reflective of the company’s strong secular positioning, durable EPS growth, and an exceptional balance sheet, Weiss concludes.

For an analyst ratings summary and ratings history on Microsoft click here. For more ratings news on Microsoft click here.

Shares of Microsoft closed at $250.79 yesterday.

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