Morgan Stanley‘s Adam Holt this afternoon offers up his impressions from meeting with Microsoft‘s (MSFT) chief financial officer Peter Klein and head of investor relations Bill Koefoed, a meeting that reaffirms his view that the company’s new product introductions will “surprise favorably,” and that the company’s profit margins will move higher.
Holt, who has an Overweight rating on Microsoft shares and a $37 price target, argues that consensus estimates on the Street don’t yet reflect “the potential of Win 8 or Office 15 in CY13 numbers,” referring to the next versions of its Windows operating system and its productivity suite.
Further, the company can look forward to favorable pricing to help move units of tablets running Windows, and he thinks versions of Windows 8 running on processors based on designs of Intel (INTC) competitor ARM Holdings (ARMH) may cut down on instances of Windows piracy around the world.
Holt details the other product cycles coming up that he thinks are less well understood:
MSFT had a significant price increase with its SQL 2012 release, with blended pricing increasing upwards of 15-20% in some cases [...] While we do not expect Windows Server 8 to see a price increase of the same magnitude of SQL, we do expect to see more modest increases. Additionally, meaningful improvements in System Center will help total ASPs, while substantial upgrades of the Hyper V capabilities should drive the premium Windows Server mix above the 25-30% levels seen today. Behind the traditional product portfolio, we sense the momentum around Azure [Microsoft's "cloud computing" service] has accelerated with MSFT now seeing more demand for both its Platform as a service offering as well as finished applications like Dynamics, Exchange Online and Office 365. As these products scale and sustain well above double digit growth, they should ultimately have a positive impact on the multiple.
Lest you doubt the lift for the stock, Holt points out some of the precedents for share appreciation around major product introductions in past: Microsoft stock has tended to rise 13% from the introduction of a beta release of Windows through the consumer roll-out of the product.
Holt actually cut his fiscal Q4 estimate for Windows revenue to $4.2 billion from $4.7 billion to reflect a coupon Microsoft is giving to PC buyers. But for next year, he raised his Windows revenue estimate to $21.2 billion, while maintaining his estimate for the “Busines Division” (containing Office) revenue at $26.1 billion. He sees operating profit margin of 38.8%, up from a prior 38.5%, to arrive at $3.16 per share in profit, up from $3.11.
That is ahead of Street estimates for $3.07.
Lastly, his argument for the stock has a lot to do with cash generation: “Cheap is not an investment thesis in tech, but with a 15% free cashflow yield, MSFT is dirt cheap and is entering a period of both accelerating revenue and EPS growth as well as likely positive revisions.”
Microsoft shares today closed up 42 cents, or 1.4%, at $29.65.
Update: FBR Capital’s David Hilal issued a somewhat more mixed report today. On the one hand, Windows 8 is “generating a lot of interest. And Microsoft’s disclosure of the terms for the upgrade — $14.99 for each copy — was “well timed,” he thinks, “as it will help mitigate a stalling of PC purchases and promote customer satisfaction during the back-toschool season.”
But unlike Holt, who bases his analysis on an expectation for PC growth this year of 4% to 6%, Hilal is modeling just 4%, and thinks “expectations for PC shipments in 2012 face macro headwinds and could shake out lower, as European weakness, consumerization of IT, and supply chain issues put pressure on the PC market.”
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