Microsoft stock is suffering from a bad reaction to a Q4 earnings report that, at first blush, looks really awful.
MSFT stock plunged more than 4.5% in after-hours trading yesterday (Tuesday). After recovering somewhat in early morning trading, shares of Microsoft Corp. (Nasdaq: MSFT) slumped back below 4% by the afternoon. Microsoft stock closed Wednesday at $45.51.
By the numbers, the Microsoft Q4 earnings produced the company's worst loss in its history. A $7.5 billion write-down of the acquisition of Nokia Corp.'s (NYSE ADR: NOK) devices business resulted in a $3.2 billion loss, or $0.40 a share.
And while that is a one-time charge, bears also focused on weakness in Microsoft's traditional moneymakers, Windows and Office.
Sales of Windows to consumers were down 13%, while sales to PC makers plunged 22%. Neither were helped by the 9.5% decline in global PC sales in the June quarter.
In addition, phone hardware revenue fell 38% - another hangover from the ill-advised Nokia deal.
But the reality isn't nearly so bad. Backing out the Nokia charge, Microsoft's EPS was $0.62 - higher than analyst expectations for $0.58.
And revenue also came in slightly higher than the forecast: $22.2 billion versus $22.04 billion.
It's not all that terrible for a company going through the biggest transition in its history. While the profits from the legacy Windows and Office businesses continue to shrink quarter after quarter, Microsoft has managed to keep the numbers from falling off a cliff.
The MSFT Q4 earnings tell us the focus on cloud and mobile is already starting to pay off. And that's what investors need to watch, not the fate of the company's aging cash cows.
Office actually represents both Microsoft's past and its future. With the subscriber-based Office 365, Microsoft is turning Office into a thriving cloud-based business.
Instead of selling customers the product once every few years, Microsoft is now selling subscriptions - and earning a steady revenue stream.
That means every time MSFT sells an Office 365 subscription, it ensures future revenue...
How Microsoft Stock Will Cash In on the Cloud
The Office 365 business is growing like crazy.
Microsoft added 3 million Office 365 subscribers in Q4 - a pace of 1 million per month. That's three times the rate of its first two years.
Enterprise cloud revenue, which includes Office 365 as well as other services, such as Azure, was up 88% in the quarter. And the annual run rate increased from $6.3 billion last quarter to $8 billion - all signs that Microsoft's cloud strategy is rapidly gaining traction.
And Office 365 is the product most responsible for Microsoft's $24.5 billion in "off-balance sheet revenue." That figure represents long-term contracts with businesses - a guarantee of revenue over an extended period.
The cloud business is big enough to have a positive impact, and it figures to a strong source of growth for a long time. It's just that for now, a lot of the new revenue is getting deferred. That's why investors need to look at Microsoft stock differently now.
But a few other bright spots in the MSFT Q4 earnings will also help fortify the company's transition.
For example, Surface tablet revenue increased 117% to $888 million. It's only 4% of Microsoft's total revenue for the quarter, but it's another source of growth.
Another mild surprise was the slow but steady growth of the Bing search engine. Search revenue was up 21% and will finally become profitable in the 2016 fiscal year.
In yesterday's conference call, CEO Satya Nadella noted several other areas of growth, including CRM (customer relations management), business intelligence and analytics, and security.
Even Windows, Microsoft's ultimate legacy business, is getting tweaked to make it more viable in the future.
MSFT Finding New Ways to Profit from Windows
With the debut of Windows 10 just days away, Nadella appears to be looking to Apple Inc. (Nasdaq: AAPL) for inspiration. The new "Windows-as-a-Service" concept is intended to make Windows into more of an ecosystem, tying together mobile, PCs, gaming, and business.
And instead of just hoping to sell consumers a copy of Windows with a new PC once every five years or so, Nadella plans to monetize Windows "with store, search, and gaming."
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This kind of aggressive approach is exactly what Microsoft has needed. Nadella has spent the past year making the hard choices that have strengthened the company for the next decade of tech.
By next year, we should start to see these efforts reflected in the numbers - and in Microsoft stock. With MSFT stock down at the moment, investors can get this stock at a discount.
"There are lots of reasons why I like Microsoft," Money Morning Capital Wave Strategist Shah Gilani said. "One, it's cheap. Two, it yields 3% and counting. Three, there's all the cash the company continues to stockpile. Four, there's new management running the house."
Gilani thinks Microsoft stock investors just need to be patient.
"This is absolutely a long-term play," Gilani said. He expects MSFT stock to hit $50 again by mid-2016 and to reach the $60 to $65 range by the end of 2016.
Follow me on Twitter @DavidGZeiler.
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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.