Last Thursday, I compared Amazon (AMZN) and Microsoft (MSFT) with a focus on their cloud businesses. I weighed in on the side of Microsoft as I remain long that name - though considerably fewer shares than a year ago or even a few months ago - based really on the firm's fundamentals as well as who is running the place.
That said, I did admit that the firm might be slightly overvalued. Microsoft had surrendered 7.2% over the first three trading days of last week. The stock has just taken back 2.2% over the past two trading days. This is where today's story picks up. Join us...
Tuesday Morning
We find out, thanks to Bloomberg News, that Microsoft is in talks to invest as much as $10B in OpenAI, which is the creator of ChatGPT. These talks are not something that came out of nowhere. As the story goes, the two sides have been talking for months. The idea, if a deal is consummate, is that Microsoft would invest in OpenAI over time, creating a years long relationship.
For some perspective, The Wall Street Journal reported last week that OpenAI had been talking about selling equity to unidentified buyers that could value the entire firm at something close to $29B.
While I am all in favor of tech firms buying growth that they can not manufacture on their own or growth that would require too much time, effort or treasure spent over the longer-term to develop on their own, I do wonder about this valuation.
If $10B and $29B are good numbers, and we really do not know if they are, then Microsoft would be doing more than investing. The firm would be a major stakeholder.
As I mentioned in that piece last week, when I think of Microsoft, I think of CEO Satya Nadella, who is one of the smartest people I have ever listened to, and who has definitely made me money over the years. If he pulls the trigger on a deal for OpenAI, there's a good chance that he understands where he's going with that. It may just be a competitive strike against the likes of Alphabet (GOOGL) .
More on Azure
Last week, the shares of MSFT were slammed by the highly rated (5 stars at TipRanks) Karl Keirstead of UBS who downgraded the name from a "buy" rating to "neutral", and took his target price down from $300 to $250. At that time, Keirstead wrote, "Azure is entering a steep growth deceleration that could prove worse than investors are modeling."
This was damaging. Azure, among other cloud services have been the firm's driver behind the growth experienced in Microsoft's "Intelligent Cloud" segment. This segment had easily outpaced growth across the rest of the firm of late.
Keirstead, who is truly a ways above other analysts, even among five stars, sees Azure as close to reaching "maturation." In that same note, Keirstead is not so keen on the Microsoft Office product either, which is in the Productivity and Business segment.
Since then, other well known analysts have opined on MSFT. On Monday, three star rated Brent Bracelin of Piper Sandler maintained his "overweight" rating on Microsoft, but reduced his target price to $247. Then on Tuesday morning, four star rated Raimo Lenschow of Barclays kept his "buy" rating on MSFT while reducing his target price to $280 from $296.
Finally, we heard from Daniel Ives of Wedbush who lost his five star rating at TipRanks in 2022 and has since regained that elite status. Ives feels that the stock has already reflected a clear slowdown in cloud and a disaster PC market over the past few quarters. Ives believes that the shift to cloud is still less than 50% penetrated and represents a massive opportunity for Microsoft going forward despite an uncertain macroeconomic backdrop.
Ives has held recent conversations with customers and partners and has confidence in Microsoft's ability to ride out this storm. Ives states that Azure growth has clearly decelerated, but that Microsoft should be able to exceed its 37% Azure growth target for the December quarter when the firm reports in late January. Ives still rates Microsoft at "outperform" with a $290 target price.
Fundamentals
I want to go over the firm's most recent (September) fundamentals with you. I mentioned last week that this balance sheet was in good shape, but I think I feel the need to put an exclamation point on that statement. Microsoft drove operating cash flow of $23.198B for the firm's fiscal first quarter. This was down small from the pace of the prior two quarters, but considerably greater than what had been experienced prior to that. This drove free cash flow of more than $15B or $2.27 per share, which is toward the higher end of the firm's range over the past few years.
At last glance, the firm had a net cash position of $107B and current assets of $161B. Inventories are not a factor for Microsoft. Current liabilities add up to $87B (of which $41B in unearned revenue), putting the firm's current ratio at a healthy 1.8. Long-term debt (including debt labeled as current) comes to $46B, which is something that the firm could pay off out of pocket more than two and a half times over.
What all this means is that Ives is right. Even if performance is as bad as feared, though Ives does not feel it will be, this firm is as well-built for the tough times as any tech/software firm I know.
Earnings
Microsoft reports earnings in about two weeks. Consensus view is for EPS of $2.30 on revenue of $53B. If realized, these numbers would be good for earnings "growth" of -6.5% on revenue growth of 3.9%. Not stellar at all. This would be a fifth quarter in six that earnings decelerated on a year over year basis from the quarter prior and a fifth straight quarter of decelerating sales. Does that earn MSFT a 23 times forward looking valuation? Probably not.
That said, am I comfortable completely exiting MSFT? Again, probably not. Nadella is taking steps to accelerate growth or at least to take on the competition. He certainly has the cash on hand to do it without really hurting the underlying fundamentals of the firm in the least.
The shares will remain in a downtrend until they are not. The daily Moving Average Convergence Divergence (MACD) oscillator is not in a good place. Relative strength seems disinterested. The 50 day SMA (simple moving average) at $239 could serve as a pivot for this name if earnings are positive.
That would put my target at $275 if the 200 day SMA would act as a slingshot and not as resistance. I'll cross that bridge when I get to it. I am willing to add in between $220 and $213. Below that I cut some risk and lick my wounds.
Right now, an investor could sell $215 MSFT January 27th puts for about $2.50. I think that looks like a decent premium at a fair strike. Of course, I would pay the $1 or so for a like amount of $205 January puts so I don't get my face ripped off.
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