Expect Cloud Acquisitions From Microsoft

According to IDC, worldwide PC shipments fell 1.7% over the year to 74.4 million units in the second quarter of 2014. This was the smallest decline reported in the last two years. Last quarter, Microsoft had announced the end of their support to Windows XP machines. The US and European markets saw growth in their commercial PC shipments as organizations continued to purchase upgrades for Windows XP systems.

Microsoft’s Financials
Microsoft’s (Nasdaq: MSFT) recent quarter was much impacted by the acquisition of Nokia phones. During the quarter, Microsoft reported a 14% growth in revenues to $23.38 billion, ahead of the market’s expectations of revenues of $22.99 billion. But EPS of $0.55 was short of the Street’s target of $0.60. Nokia brought in $1.99 billion in revenues, but reduced the company’s profit by $0.08 per share.

By segment, revenues from phones, devices, and consumer segment grew 42% to $10 billion. Their commercial division revenues improved 11% to $13.48 billion.

Meanwhile, the company recently announced plans to lay off an additional 18,000 employees worldwide, nearly 14% of their workforce. Most of the lay-offs are expected to come from Nokia as it targets to cut down Nokia’s losses by $1 billion by 2015. This is among the biggest layoff ever announced by Microsoft. Microsoft is looking to become a more nimble and focused company through the move.

Microsoft ended the year with revenues growing 12% to $86.83 billion and EPS rising 2% to $2.63.

Microsoft’s Mobile First, Cloud First Initiative
Under the leadership of Satya Nadella, Microsoft is determined to become the leading player in catering to a “mobile-first and cloud-first” world. Within mobile phones, Microsoft is restructuring what they bought from Nokia. They plan to shut down support for the low end Nokia X and Asha series phones, which were used by Nokia to establish presence in the smartphone market of the price conscious emerging markets. These phones were being run on versions of Android and the Symbian OS.

Instead, Microsoft announced plans to release a lower priced version of Lumia, the Lumia 530. The phone features a curved back shell, 4-inch 854 x 480 screen, 5 MP camera, 1.2 GHz Qualcomm Snapdragon 200, 512 MB of RAM and 4 GB of on-board storage with a micro SD card slot. It runs on Windows Phone 8.1 which includes the voice-activated assistant Cortana and comes with pre-installed Microsoft Office apps. The phone will retail for $115 compared with the lowest price Nokia X phone of $125 and is expected to help attract users to the world of Windows Phone.

This will not address the gap that would be left by the closure of the Asha series phones which were priced at nearly $60 each. But it appears that Microsoft is walking out of that segment, given there are others who are making these phones much cheaper and squeezing out the thin margins.

It does make sense for Microsoft to focus their energies on expanding the Windows OS market share instead of supporting phones on other operating systems. According to an IDC report, Windows Phone currently has a 3% market share, which is projected to grow to 7% by 2018. During the same period, Android’s share is projected to decline from 78.9% to 76%.

Microsoft is still struggling with the sales of Surface devices. During the quarter, sales of the tablet device fell to $409 million compared with $500 million reported a quarter ago. In fact, during the quarter, Microsoft also took a hit of $38 million on account of closing down the development of Surface Mini. The tablet category is beginning to fumble, as we saw in Apple’s recent earnings report.

Within the cloud, Microsoft has seen strong success. During the quarter, the Azure platform saw revenues grow 147%, delivering a $4.4 billion annual revenue run rate. The subscription model of Office 365 has also gained strong adoption with the company reporting more than 5.6 million subscribers and revenues more than doubled over the year.

Microsoft’s stock is trading at $44.50 with a market capitalization of $366.6 billion. It touched a 52-week high of $45.71 earlier this month.

Satya Nadella’s strategy to focus the company on mobile and cloud makes a lot of sense. There are lots of great cloud businesses to acquire to roll-up a powerful portfolio that will get them great leverage. On the mobile side, the Nokia acquisition needs to be integrated and managed well, and application layer on top of Lumia needs focused execution.