For the past 10 years, Microsoft's (
MSFT
) stock has traded in a relatively tight range of $20 to $30.
According to our estimates, however, Microsoft is currently worth
around $41/share, implying a premium of about 40% to the market
price. In contrast to our forecasts, we think the market expects
Microsoft's market share for the OS and Office divisions to
decline. Our thesis is centered around Microsoft being able to
maintain its market leading position, especially for its Office and
Windows OS offerings.
Microsoft's flagship products include the Microsoft Office
Suite, Windows Operating Systems and Windows Servers. The company
primarily competes with Google (
GOOG
) and Apple (
AAPL
) in productivity software and OS markets.
See our complete analysis of Microsoft here
New interface with lower costs for consumers
Over the years, Microsoft has been criticized for not innovating
its product offerings and taking its dominant market position for
granted. However, with its newest offerings, Office 15 and Windows
8, the company is focusing on making its platform more intuitive
and putting the focus back on the consumer. We think that this
redesign is a step in the right direction and will enhance
Microsoft's ability to retain market share relative to competitors.
Additionally, the company is reducing the price for upgrade to its
new Windows 8 platform to remain competitive against free open
source software such as Linux.
Microsoft has also taken steps to redesign its user experience
for its online properties; it is deprecating Hotmail for a sleeker
Outlook.com. These interface changes show greater focus on consumer
usability, and can help attract users, going forward. You can
assess the impact of changes in Office Suite market share on our
stock price estimate by using the chart below.
New OS can drive synergies
In our view, the market may be dismissing the chances that a
consumer using Windows OS on PC will buy a Windows-based device for
tablet or phone. The availability of Windows 8 across all platforms
is likely to encourage user adoption on multiple platforms. For
example, in the emerging markets, an individual who cannot yet
afford a PC can buy a Windows-based phone because it is cheaper.
And, if the user saves up for PC in the future, the chances that he
will choose a Windows-based PC are higher due to familiarity with
the Windows OS. We think the desire to have the same experience
across multiple devices and the general reluctance among users to
switch operating systems will help Microsoft maintain market share
for its flagship products.
Risk: Increased competition and bad acquisitions
As stated above, we expect Microsoft's market share for its
biggest products will stay more or less flat until the end of our
forecast period. If Windows 8, Office 15 or a new iteration of
these products fail to attract users or, still worse, they leave
the Windows platform, we could see a downside to our price
estimate. Additionally, if a competing product gains traction
relative to the Windows OS and Office suite, we could see a decline
in market share, which would consequently drag the company's
value.
Another concern is the company's history of paying extravagant
amounts of money for new acquisitions. Microsoft wrote down
aQuantive in the most recent quarter and, if future acquisitions
are not successful, they could destroy value for the company by
wasting cash.
Conclusion
Overall, we think our $41/share valuation for Microsoft is
justified, implying a 40% upside to the market price. We don't
expect the company's largest segments to go away anytime soon and
will likely maintain their market shares till the end of our
forecast period. The depressed market valuation could be a result
of lack of faith in management or overestimation of the impact that
trends in the open-source, free software space will have on
Microsoft's value.
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