Microsoft Wisely Exits Smartphone Market?

05/25/2016 9:37 am EST

Focus: TECHNOLOGY

Michael Berger

President & Founder, Technical420.com

After Microsoft acquired Nokia in 2013, the smartphone market has become more saturated and the company fired thousands of employees. Microsoft has pretty much exited the smartphone market and Michael Berger the Associate Editor of MoneyShow.com, highlights how this is a good decision due to how this business negatively impacted the company’s earnings during the most recent quarter.

In an effort to focus on its profitable growing businesses, Microsoft (MSFT) announced that it is making further cuts to what is left of its weakening smartphone business.

The company announced plans to eliminate up to 1,850 jobs and will take an accounting charge of $950 million as a result of this decision. Most of the people that will be affected by this are based out of Finland, where the mobile business that Microsoft acquired from Nokia a few years ago originated.

Cost Cutting Measures Needed

After Microsoft acquired Nokia for $7.2 billion in late 2013, approximately 25,000 employees were added onto the company’s payroll.

Less than year later, Microsoft announced that it was cutting 18,000 jobs, most of them related to the Nokia deal.

Last year, Microsoft cut an additional 7,800 jobs, lowered the number of smartphones it offered and took a $7.6 billion accounting charge.

A Necessary Business Decision

We think that this move was necessary as Microsoft’s most recent earnings were impacted by its ailing smartphone business.

The smartphone business is saturated and even the industry leaders, Apple Inc. (AAPL) and Samsung, are both seeing a decline in the number of units sold.

Market saturation is a quandary that will not fade anytime soon. With only incremental improvements in each new generation of phones, it is much harder to convince smartphone owners to switch over to new models.

Third Quarter Highlights Weakness

In the most recent quarter, Microsoft said its Intelligent Cloud business grew 8% and generated $6.1 billion in revenue. Within this segment, revenue from its Azure business grew 120%.

Meanwhile, the More Personal Computing segment, which is comprised of its PC business generated $9.5 billion in revenue. Although these numbers seem impressive, the More Personal Computing segment saw a 26% decrease in patent licensing revenue, as the Android market shifts to lower cost phones from manufacturers that Microsoft has no agreements with.

Microsoft licenses patents to big Android handset makers like Samsung and at one point was reportedly booking more than $2 billion a year from this business.

Outlook is Bright

Our investment thesis is based off of both gross and operating margins reversing its declining trend. We believe that MSFT’s Azure business could generate $8 billion in revenue during fiscal year 2018 and if operating margins continue to improve, this could add up to $0.20 to Earnings Per Shares (EPS). Another component of our thesis pertains to MSFT’s commercial software business turning the corner and recording positive mid-single digit growth. This is a major improvement after recording negative growth last year as the headwinds from a Windows XP refresh dissipates.

Not only does Microsoft represent a growth opportunity for investors, but the company also offer a 2.8% dividend. We view Microsoft as one of the few hyperscale cloud vendors able to integrate infrastructure-as-a-service (IaaS), platform-as-a-service (PaaS), and software-as-a-service (SaaS) with a vast installed base of server/client software.

We think the decision made by management will benefit Microsoft in future quarters and see value in MSFT at current levels. The shares are down more than 7% this year and we see more than 10% upside to current levels.

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