Now that two of Wall Street's biggest names have put an unusual "sell" rating on Microsoft Corp. (Nasdaq: MSFT) stock, investors might be tempted to dump shares of the tech giant.
That would be a mistake.
But before we get into why Goldman Sachs Group Inc. (NYSE: GS) and Citigroup Inc. (NYSE: C) are wrong about Microsoft stock, let me share with you what they don't like about the Redmond, Wash.-based company.
Goldman was the first to make the negative call back in early April.
"We are reiterating our Sell rating on Microsoft, as we continue to see risk to both revenue and EPS forecasts for the remainder of this fiscal year, as well as for FY16 and FY17," wrote Goldman analyst Heather Bellini. "We see consensus estimates as too aggressive."
The consensus one-year Microsoft stock price target is $48.19. At the time Bellini put a 12-month $38 target on MSFT stock, later nudging it up to $40. That's 16% below the current price of $47.60.
Bellini and her team see "headwinds" for Microsoft's main businesses. Specifically:
- Windows will continue to face tough compares this year, as people last year were compelled to upgrade their machines when Microsoft ended support for Windows XP.
- The Commercial unit also faces tough compares because last year Microsoft had steep price hikes on many of its server products.
- Windows 10 won't bring in much revenue for a while, as Microsoft plans to offer it initially as a free upgrade.
- PC sales forecasts are flat.
- The shift from one-time licenses to subscriptions for products like Office will stretch revenue out over a longer period and decrease margins.
Citi Matches Goldman's Sell Call on MSFT Stock
Two weeks later Citigroup slammed MSFT stock.
"We rate shares of Microsoft a Sell. We believe shares are being buoyed by excitement around new CEO Nadella and cloud services," wrote Citigroup analyst Walter Pritchard. "MSFT is wrestling with difficult strategic issues where we believe there are no easy answers."
Specifically, Pritchard took issue with:
- Declining PC sales that Microsoft has not offset by increasing sales in the mobile market.
- Cannibalization of its Windows and Office cash cows by cloud businesses with lower margins.
- Increasing debt on the balance sheet as Microsoft makes up for decreasing cash flow by borrowing to keep promises to buy back stock.
- The continuing drag on earnings from the strong U.S. dollar.
Pritchard has an even more pessimistic MSFT stock price target of $37 a share.
We've been waiting to see if Microsoft's strong beat on its fiscal Q3 earnings, which it reported 10 days ago (April 23), would bring a revision.
While Wall Street rewarded MSFT stock with a 10.5% gain the day following that earnings report, both Citi and Goldman have stood their ground.
They just don't get Microsoft...
Why Microsoft Stock Is a Buy
While Microsoft undeniably faces challenges, it has spent the past year laying the foundation to meet those challenges. And its efforts already are bearing fruit.
Microsoft's cloud businesses grew 106% in the most recent quarter. The quarter before that, it grew 114%. And the quarter before that, it grew 128%. In fact, Microsoft's cloud revenue has seen triple-digit growth for seven consecutive quarters.
CEO Satya Nadella said the cloud business annual run rate is now $6.3 billion.
And this rapidly growing business segment has lots of runway in front of it. The cloud computing market is expected to double from last year to 2018, from $56.6 billion to $127.5 billion.
Money Morning's Defense & Tech Specialist, Michael Robinson, believes the Microsoft transition is working. He says MSFT stock has "enormous upside."
He pointed to the 18% rebound in MSFT stock since an April 2 low of $40.29.
"I believe this huge rally gets down to two factors - its growth in cloud computing and the quality of leadership of CEO Nadella," Robinson said. "The two actually go hand-in-hand. After all, Nadella has made growth in the cloud one of his main objectives."
Robinson also hailed the company's announcement last week that it would provide tools to help developers of Android and iPhone apps easily create Windows versions.
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"I believe the program shows that Microsoft is taking a page from Apple's playbook," Robinson said. "Rather than sell a collection of disparate tech products, Microsoft wants to create an Apple-style ecosystem in which products work together in a unified way."
Money Morning Capital Wave Strategist Shah Gilani agrees. At the very time Goldman was trashing Microsoft stock, he was defending it.
"There are good reasons why Microsoft has been sliding backward," Gilani said in early April, at the very start of the recent rally. "But if you study them carefully, you'll see that those reasons are fully baked into the new lower price. So we're definitely not overpaying here."
Regarding Goldman's concerns about Windows 10 revenue, Gilani said they just don't get it.
"You acquire new customers by some freemium programs and hold onto old customers by engaging them with new and better products," he explained. "You enlist them to basically self-market the company's products by giving them a lot of reasons and access to try other integrated products in the ecosystem, and you monetize all that. Personally, I love the strategy."
Gilani concedes there are headwinds, but counters that they will be short-lived.
"Are there slippery rocks ahead? Yes, there are," Gilani said. "But the further down the new path the company gets the drier the ground is, until 2016, when it's going to be rock hard and as fast as the Daytona International Speedway. That's why we're buying Microsoft."
Gilani recently raised his Microsoft price target from $60 to $65 over the next 18 to 24 months.
Wrong Way Wall Street: We shouldn't be too hard on Goldman Sachs and Citigroup for flubbing their Microsoft stock forecast. The truth is, Wall Street analysts have a terrible track record when making predictions about the stock market. We've got proof of just how wrong they are...
Follow me on Twitter @DavidGZeiler.
Related articles:
- Business Insider: Goldman Sachs on Microsoft: Sell now
- Business Insider: Citi agrees with Goldman Sachs: Sell Microsoft now
About the Author
David Zeiler, Associate Editor for Money Morning at Money Map Press, has been a journalist for more than 35 years, including 18 spent at The Baltimore Sun. He has worked as a writer, editor, and page designer at different times in his career. He's interviewed a number of well-known personalities - ranging from punk rock icon Joey Ramone to Apple Inc. co-founder Steve Wozniak.
Over the course of his journalistic career, Dave has covered many diverse subjects. Since arriving at Money Morning in 2011, he has focused primarily on technology. He's an expert on both Apple and cryptocurrencies. He started writing about Apple for The Sun in the mid-1990s, and had an Apple blog on The Sun's web site from 2007-2009. Dave's been writing about Bitcoin since 2011 - long before most people had even heard of it. He even mined it for a short time.
Dave has a BA in English and Mass Communications from Loyola University Maryland.