Microsoft

Microsoft has incredible competitive advantages in their base business. They are the de facto standard for both operating system and productivity tools for servers, desktop and laptop computers. This has led to deep relationships with most businesses in the world across users and IT departments. Their bundling strategy and interoperability with their existing products make adding new products and features easy and allows them to be a fast follower – given that new products are normally introduced for free (added to an existing bundle) and operate in the MS ecosystem, their products only need to be “good enough” for acceptance.

Those competitive advantages allowed Microsoft to dominate the world of PCs and on-premise IT infrastructure in the previous millennium. The more recent shifts – the move to mobile devices and the shift of infrastructure to the cloud – has threatened this. It is clear that Microsoft’s dominant position is being eroded as the market develops away from their traditional strengths. However, the business has admirably managed the transition and has gained strong share in new areas by leveraging off their enterprise ecosystem and its cash flows. A lot of this can be attributed to the visionary leadership of Satya Nadella who enabled Microsoft to embrace mobile and cloud, be more open and expand into new areas.

The future looks bright with their cloud and SaaS businesses now representing 47% of revenue and still growing over 30% year on year. We believe Microsoft can continue to reliably compound their earnings base at double digits for years to come and that a low twenties multiple on free cash flow (that is returned to shareholders) is an attractive price for such a high-quality earnings stream.