Last week, Goldman Sachs analyst Heather Bellini upgraded Microsoft Corporation (NASDAQ: MSFT ) from "Neutral" to a "Buy," largely in response to the company's growth opportunity in cloud computing. Moreover, Bellini upped her price target on Microsoft stock to $68 … 13% better than the stock's current value.
Source: Johannes Marliem Via Flickr
It was certainly an encouraging development for owners of MSFT stock.
Yet, those who know the story well will know that rival Amazon.com, Inc. (NASDAQ: AMZN ) owns the biggest piece of the cloud computing market, and besides, MSFT's cloud margins have been shrinking even as that division's revenue has grown.
Thing is, both of those things are changing.
WhatYou Need to Know About MSFT Stock
Bellini said a lot with her upgrade, but there was little doubt as to the crux of her bullish thesis for Microsoft stock :
"Azure is the #2 market share vendor in the cloud space, and has grown 100 percent or more yoy eight of the last ten quarters, and in fact growth accelerated in Q3 16 … With a large Microsoft customer base and strong C-level relationships, we believe Azure can continue to grow revenue and improve margins over time."
As was noted, in conjunction with the upgrade, Bellini thinks the cloud growth opportunity will push MSFT stock up to a price of $68, sooner or later.
If margins improve over time as Azure - the platform MSFT created to manage the cloud - gains popularity, it would be a reverse of the direction things have been pointed for the past few quarters. That is, cloud revenue has been shrinking, while cloud margins have been narrowing.
For perspective, in the recently completed Q1 of fiscal 2017, Microsoft turned $6.38 billion worth of revenue into operating income of $2.06 billion. In the same quarter a year earlier, the company only drove $5.89 billion worth of sales, but converted $2.39 billion of that into income.
Click to Enlarge Source: Microsoft Corporation
Don't jump to conclusions about the trend, however. As the company's recent quarterly deck explained , "Operating expenses increased $408 million or 21%, mainly due to higher reserach and development expenses and sales and marketing expenses."
That spending won't go on forever. The ROI on the investment, however, will last in perpetuity.
Still, the cloud market is dominated by rival Amazon; MSFT is a distant second. Can Microsoft really take what Amazon has?
A lot of people seem to think so, and for good reason.
As of the end of last year, Amazon Web Services controlled 31% of the public cloud market, versus MSFT's 9% share. In the meantime, while Amazon still controlled 31% of the cloud infrastructure as of the end of the second quarter, Microsoft had upped its share to 11% . Granted, Amazon's year-over-year growth in cloud revenue was an impressive 53%. Microsoft's was more impressive though, at 100%.
That growth in MSFT's cloud services (and Azure in particular) isn't expected to abate anytime soon either. In a poll recently taken by Morgan Stanley, 20% of CIOs said their companies currently use Amazon Web Services, while 10% say they're using Azure. Within three years, though, 31% of those CIOs anticipate they'll be using Microsoft's Azure platform , while only 29% will be using Amazon Web Services.
And even if MSFT doesn't catch up with and then eclipse Amazon, the value of Microsoft stock is positioned for appreciation stemming from the advent of cloud computing.
Bellini and teammate Heath Terry believe the public cloud computing market will grow from $32 billion for 2016 to $137 billion to $137 billion by 2020.
Bottom Line for Microsoft Stock
It's not very often that one division of a multi-faceted company - particularly when that one division is relatively new - is a reason to buy a stock. MSFT stock is arguably a strong exception to that norm.
No, cloud computing isn't the bulk of MSFT's revenue yet, only accounting for about a third of the company's revenue last quarter. There's little doubt that cloud is the most dynamic and fastest-growing of Microsoft's segments, however, and it will be the breadwinner in the near future.
While the top line growth will be more than firm, as Jim Cramer said recently, as the company's cloud projects scale up, margins should start to increase. That's what owners of Microsoft stock have been waiting for … patiently.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.
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