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Founded in 1975, Microsoft Corporation is one of the biggest technology companies, engaged in developing and supporting software products, services, and devices. The company has a dominant position in the personal computers (PC) market with more than 80% of the market share for its operating systems. The company’s software products include operating system software, server application software, business and consumer applications software, software development tools, and Internet and intranet software. Besides, Microsoft also designs, manufactures, and sells a range of devices, including personal computers (PCs), tablets, phones, video game consoles, and digital music entertainment devices. It offers services such as cloud-based solutions, and provides solution support and consulting services. The company’s platforms and tools are widely used by individuals, small and large businesses, startups, and both public and private sector companies to drive productivity and efficiency.
Under the leadership of the current CEO, Satya Nadella, MSFT has shifted focus to software and services, more specifically on growing MSFT’s Commercial Cloud business comprising Office 365 Commercial, Azure, the commercial portion of LinkedIn, and Dynamics 365. We expect Commercial Cloud to be the primary driver of growth going forward. MSFT’s diverse portfolio across cloud, edge, hybrid, and on-premise environments positions it well for the future, although temporarily shrouded by the COVID-19 uncertainty.
Microsoft has three business segments: Productivity and Business Processes, Intelligent Cloud, and More Personal Computing.
MSFT holds 80% market share in operating systems
Microsoft's Productivity and Business Processes segment offers a portfolio of products to enhance corporate productivity, communication, and information services. One of the segment’s major products is Microsoft's Office software suite, including both Commercial and Consumer divisions. The segment also comprises business solutions products such as Dynamics and LinkedIn, a professional networking site. In FY 2019, the segment generated revenue of $41.2 billion (~33% of total revenue) and operating income of $16.2 billion (~39% of segment revenue).
The segment has been benefiting from its offering of productivity and collaboration tools and services (Office 365, Dynamics business solutions, Teams, Relationship Sales solution, Power Platform and LinkedIn), providing the company a strong base of recurring revenue, having multiyear contracts with commercial clients. Microsoft has continued to move its product portfolio to the cloud, and we believe this will drive future growth, underpinned by its strong market position (>80% of market share) in enterprise Office Suites, further helping the company’s hybrid-cloud ambitions.
Although continued investment in cloud,AI engineering, and expenses related to commercial sales capacity weighed on margins over the past few years, we believe they will improve to previous levels as the business starts maturing in the upcoming years.
Strong recurring revenue stream from productivity tools through multiyear contracts with commercial clients
Office Commercial offers a range of products and services to enhance personal, team, and organizational productivity and is widely used in new markets such as first-line workers, small- and medium-sized enterprises, and growth markets for communication, collaboration, analytics, security, and compliance. The core offerings include Office 365 (recently rebranded as Microsoft 365) subscriptions and Office licensed on-premises, comprising Office,Exchange, SharePoint, Microsoft Teams, Office 365 Security and Compliance, Skype for Business, and related Client Access Licenses (CALs).
Office commercial revenue has been benefiting from continued growth in Office 365 Commercial, driven by installed base expansion across all workloads and customer segments. In Q3 2020, Office Commercial products and cloud services revenue grew 15% y/y on a costant currency basis (cc) (vs. 14% in Q2). Whereas, Office 365 Commercial revenue increased 27% y/y cc, with Office 365 Commercial subscription growth of 20% to reach 258 million active users. For Q4 2020, the management expects Office 365 to be the growth driver for Office commercial revenue, with a strong upsell opportunity, particularly for its advanced security solutions.
Office Consumer mainly focuses on individuals and families, offering Office 365 subscriptions and Office licensed on-premises, and Office Consumer Services, including Skype, Outlook.com, and OneDrive.
The office consumer segment holds strong recurring subscription revenue on the back of a strong Office 365 Consumer subscriber base, which reached 39.6 million in Q3 2020, benefiting from the increased demand for its products and cloud services. Office Consumer products and cloud services revenue recorded growth of 17% y/y cc in Q3 2020.
Rebranded Office 365 as Microsoft 365
With the addition of new functionalities, the company recently rebranded its Office 365 subscription service as Microsoft 365, thereby further expanding its end- market share and ensuring meaningful monetization over time. Moreover, its large Office user base and higher security spending helps to widen the lead over rivals.
LinkedIn, acquired by Microsoft in 2016, is the world's largest professional network on the Internet, offering various free services including hiring, marketing, selling, and learning. In addition to free services, LinkedIn offers three categories of monetized solutions to both enterprises and individuals: Talent, Marketing, and Premium, including Sales Solutions. These solutions also comprise elements such as hiring, learning and development, advertising, and professional networking. On November 16, 2018, LinkedIn acquired Glint - an employee engagement platform for businesses and other organizations - to expand its Talent Solutions offerings.
Acquired LinkedIn in late 2016, expanding its offerings to the professional network
In Q3 2020, LinkedIn revenue increased 21% y/y (22% cc) to $2.1 billion, reflecting continued innovation across its Talent portfolio: Talent Solutions, Talent Insights, Glint, and LinkedIn Learning. With the acceleration in engagement, LinkedIn sessions continued to grow, reaching 690 million (as of Q3) professional members who connect to learn new skills and find new opportunities.
With fewer job postings amid the COVID-19 pandemic, lower search revenue and weakness in transactional revenue could weigh on LinkedIn’s revenue in Q4 2020, with deceleration trending in the mid-single digits.
