[TOP STORY] Microsoft very different from its heyday in the late 90s


SIMON BROWN: I’m talking now with Keith McLachlan at Integral Asset Management. Keith, you bought Microsoft. I’ll tell you, it’s a painting that I used to look at for a long time. There was this massive rally in the late 90s. It peaked I guess in early 2000 and then didn’t come back above those levels until 2017. Talk about a lost decade, with the former CEO Steve Ballmer more than anything else, the United States Department of Justice. [when Microsoft was accused of monopolising the personal computer market].

But [with CEO] Satya Nadella – this is a new company and a very different Microsoft than it was in the heyday of the late 90s.

KEITH McLACHLAN: Hello Simon. Absolutely. What you’ve really highlighted is the shift in business from product sales to cloud sales, which is a completely different dynamic. You can see it in the cash flow, you can see it in the risk profile. You turn one-time sales into annuity contracts, and it’s a much better deal, and all the economics are now in its favor.

SIMON BROWN: They are. On the one hand, it is its openness. I remember, I’m on Mac, and you could get Office for Mac, but it would be like five years old. And that’s part of what Satya Nadella did, where he basically said, “You know what? We want our software absolutely everywhere”. The bet [is] on the cloud – and Azure is there with, with AWS [Amazon Web Services] as the great player.

KEITH McLACHLAN: Absolutely. I’m a big fan of AWS. I’ll get to that in a moment, but the cloud is really big business when you talk about it here – the basic cloud. So we’re not talking about guys offering cloud stuff, just a basic cloud offering. It is a large-scale enterprise. Our point of view is that this market will probably consolidate globally into two or even three players.

But if you compare AWS and [Microsoft] Azure versus Google Cloud, Google Cloud is miles behind. They are just losing. If they will be able to continue, we will see.

But the problem is, you’re not just buying cloud on Amazon. When you buy AWS, you buy what last quarter was actually a loss-making e-commerce business; it is the second largest employer of labor in America. It hardly looks like technology to me, and it’s very exposed to payroll inflation.

When you buy Microsoft, however, you get the cloud – which accounts for about a third of revenue and is growing 30-40% year over year – as the winner in this race. But you’re also buying a very, very defensive product company.

We are therefore talking about a commercial office, a consumer office. You get LinkedIn, – which, don’t forget, hidden in the middle, grows about 30%, 40%….

SIMON BROWN: And earn real money, amazingly.

KEITH McLACHLAN: Certainly, certainly. They’ve figured out what their niche is and they’ve absolutely dominated it. Talk to anyone at a recruiting agency and you absolutely need a LinkedIn membership. There is no other way to manage this industry now.

And then you get the personal computing side where, remember, they’re doing an acquisition of Activision Blizzard to lock into the Xbox side, and really consolidate that. It’s terrifying, given Microsoft’s scale, to consider Activision Blizzard as an add-on acquisition. But it really is.

SIMON BROWN: I just looked up – I always forget they own LinkedIn, [for which the] annual revenue for fiscal year 2022 was nearly $14 billion, up from $8 billion in 2020. As you say, it kind of hides there.

We talked about the cloud part there and it’s defensive. Office of course – businesses all over the world use Office. Can they move on? Yes. Are they going? Almost certainly not. [And] the game component, Activision [Blizzard], assuming the deal is done. Of course, they also have Xbox. Is this giant insignificant in their lives, or is it really another sort of almost LinkedIn baby?

KEITH McLACHLAN: Well, I would say it’s not important in their life. When you look at Microsoft, two-thirds of its revenue comes from highly defensive, inelastic, and almost unsubstitutable products. We’re talking Commercial Consumer Office, we’re talking [365], the cloud. Once you’ve decided on a cloud provider, it’s Azure or AWS, it’s one or the other. I mean, Google Cloud is miles behind and every other cloud provider is a rounding error in terms of market share. You are probably mostly locked up. These are therefore deeply defensive incomes. The game is enjoyable and it’s exciting and it’s interesting. We’ll see what they do with Activision Blizzard once that’s done, but I don’t think it’s meaningful.

Two-thirds income, very defensive, very inelastic, and they have good pricing power with few substitutes.

I guess Facebook and Google….

Stepping back, one of the big names in the stock market mistakenly calls big tech “big tech.” All of these companies are completely different. And Facebook and Google, their revenue comes from advertising, and it’s cyclical, it’s not defensive. It’s very competitive.

Two-thirds of Facebook’s revenue is defensive with pricing power. These are totally different characteristics.

SIMON BROWN: That’s a great point. I get it, they’re all high tech, yes, but they have those nuances. I like this. Inelastic, irreplaceable – perhaps this is the heart of Microsoft. And these are the real deal there.

We will leave it there. Keith McLachlan at Integral Asset Management, I like the early morning.

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