Is Microsoft The Most Essential Company On Earth? (NASDAQ:MSFT)


Microsoft France headquarters entrance in Issy les Moulineaux near Paris

Jean-Luc Ichard

Overview

Is Microsoft Corporation (NASDAQ:MSFT) the most essential company on earth? In my opinion, they have a strong case for claiming this title because of one major factor – there are very few American (or international) businesses that could operate without them. Microsoft’s 365 productivity software is the cornerstone, an essential component, of nearly all major American companies. For those of us working full-time in corporate America, take a few minutes to imagine how you and/or your employer would function day-to-day without Microsoft. Think about the epic standstill that would result if you logged into your work computer tomorrow without Outlook, Excel, Teams, SharePoint, etc… What would you do?

With shares down 22% in 2022, is now a good time to open or add to a position in this cornerstone of American business? Is the competitive moat wide enough to warrant a premium on shares? Will Microsoft be able to keep the competition at bay? Let’s find out.

Chart
MSFT data by YCharts

The Cornerstone

Over the past 10 years, I’ve been employed by two different Fortune 250 companies and, speaking from experience, those two companies would be in serious trouble if the Microsoft switch turned off tomorrow. Both of the companies are utilities, so imagine the impact to the general public if there were to be a disruption in service. In a sense, both companies are almost hostage to Microsoft, relying on their products and services for communication, data storage and analytics, and collaboration, to name a few. If I were a betting man, I’d wager there are about 450 other companies in the Fortune 500 that are in the same boat.

How many other companies have the vast majority of American business relying on them for essential, day-to-day operations? You can certainly count them on one hand or less. The Apples (AAPL) and Meta Platforms (META) of the world, while important, mainly offer convenience and comfort. To a large degree, the same goes for Google (GOOG, GOOGL) and Amazon (AMZN). I’m aware Google and Amazon have some Cloud-based revenue, but I’m referring to their core business.

annual growth in MS Teams users

MS Teams User Growth (office365itpros.com)

Yes, a day without an iPhone or Facebook would be inconvenient, but would it inhibit my ability to perform at my job or prevent my company from turning a profit? Would it inhibit a business’s day-to-day operations? For some, maybe, but I have a hard time believing it would for most. In reality, many of the largest tech companies are high-tech billboards, relying solely on advertising for revenue. What would the impact be if there were a marked reduction in ad spend spurred by AI, for example?

Don’t get me wrong, the titans I mentioned are high quality, high performing businesses producing a ton of cash flow with strong balance sheets. I own shares in a few of them and recommend you do the same. I’m just saying I don’t think their absence would have as profound an impact on American business and the economy as would Microsoft’s. For this reason, I think Microsoft very well may be the most essential company in the world.

What’s The Alternative?

Microsoft currently holds a near 90% share in the productivity software market. One factor making Microsoft so powerful is there are few comparable replacements for its vast suite of products. I’m not sure if competitors ponder to themselves, “why bother?” or if the cost to develop, market, and compete with Microsoft is too costly. Probably a little of both.

Either way, Microsoft’s top formidable competitor is Google, who offers a suite of similar products under Google Workspace. However, with an approximate market share around 10%, Google still has a ton of ground to make up to rival Microsoft 365. Currently, Google Workspace is stealing around 1% to 2% in market share per year from Microsoft 365. When you look at the big picture, it’s a drop in the bucket for Microsoft. Not to say the trend won’t continue or speed up, but it doesn’t feel too alarming at this point in time.

For some perspective, Google reports Google Workspace revenue under the Google Cloud operating segment. In Google’s Q2 2022 earnings release, they reported $6.3 billion in revenue under Google Cloud which includes the following business operations:

Google Cloud includes Google’s infrastructure and platform services, collaboration tools, and other services for enterprise customers. Google Cloud generates revenues from fees received for Google Cloud Platform services, Google Workspace collaboration tools, and other enterprise services.

It’s difficult to pinpoint revenue for Microsoft 365 due to their numerous reporting segments. Nonetheless, in their most recent quarter, Microsoft reported Cloud revenue of $20.9 billion and Productivity & Business Processes revenue of $16.6 billion. Both segments mention Office and/or Cloud products, so it’s safe to say Microsoft 365’s quarterly revenue is in the tens of billions of dollars. A considerable cushion over Google Workspace’s less than $6 billion.

MS cloud revenue growth

MS Cloud Revenue Growth (office365itpros.com)

Switching Is A Pain

Another reason I’m not too concerned about Google overtaking Microsoft in the productivity software space is because switching is a pain, more mentally and emotionally than physically. From an IT perspective, I’m sure switching from Microsoft to Google (or vice versa) is only a minor inconvenience due to security, system integration, software updates, physical computer needs, etc…, but I have to believe Google and Microsoft make it as seamless as possible. More than anything, I think it comes down to users being set in their ways and not wanting to switch.

Personally, switching from something I’m pleased and/or familiar with to something I’m not, is a major deterrent. It’s the reason I still have an iPhone and have never considered a Samsung or Android device. It’s the same reason I’ve never purchased Apple’s MacBook for my personal computer. Android and MacBook may very well be superior products (I expect to see this in the comments), but they don’t interest me because I’m comfortable and confident in what I already have. I have no desire to learn these new systems, and I think the same applies to many Microsoft 365 users. I speculate Google’s market is largely made up of young companies making their inaugural purchase of productivity software products.

So Is It A Buy?

At $263, not yet. While I love the business and think it merits the title of “most essential company on earth,” I can’t recommend buying Microsoft here because I don’t think it offers a market-beating return. The starting price is simply too high given its growth prospects. You may think I’m crazy (but that’s not fair! name the song), but $200 is my ideal entry. I’d probably dabble at $220, but the $200 mark is where I think Microsoft offers a market-beating opportunity.

I believe this because, using a market multiple approach (P/E and P/FCF), I put a 2029 target price of $380 on Microsoft. For the valuation, I assumed a revenue CAGR of 9.4%, a 0.8% reduction in annual shares outstanding, net margins of 33.5%, FCF margins of 27.5%, and price multiples of 22x for P/E and 26x for P/FCF, both well below their 5YR averages.

I averaged the results of both methods to arrive at a target price of $380. From today’s price of $263, that represents a 5.8% CAGR. Not exactly a market-beating return in my opinion. I think investors are better off staying on the sidelines in hopes the market offers up a better opportunity.

excel market multiple valuation

MSFT Valuation (Author’s personal data)

Bear Case

My bear case for Microsoft is two parts. While I believe the bear case to be low probability, it’s a probability, nonetheless. Part 1 is that Google continues to compound their market share growth in the productivity software space, stealing greater share from Microsoft. Google is stealing around 2% today, but as they continue to build their base, word of mouth and customer referrals will continue to spread. This has the potential to have a compounding effect on Google Workspace’s revenue. Part 2 is that while Google continues to perform, Microsoft fails to innovate. While I believe Microsoft offers a superior product today, complacency on their part could cause that gap to close. These two parts combined have the potential to de-throne Microsoft as “most essential company on earth.”

Conclusion

Microsoft is the cornerstone of American business, enabling successful operation of day-to-day business activities. Much of America would come to a grinding halt if Microsoft closed its doors tomorrow. It’s for this reason I believe Microsoft just may be the most essential company on earth.

However, at $263 per share, I don’t believe Microsoft offers investors market-beating potential. A great American company for sure, but not a great American investment at current levels. Investors should consider staying on the sidelines until Mr. Market offers up a better opportunity in the future.

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