Microsoft's Fundamentals Are 'Resilient' And Long-Term Strategy Is On Track

Shares of Microsoft, which makes the popular Windows OS, remain weak after it reported mixed results for its third quarter.

Cloud, Transactional Server

"With commercial cloud the top priority, the growing Azure mix drives the transition to a lower gross margin profile, but emphasis remains on net income growing through revenue growth and expense efficiencies. Another round of phone staff cuts will help right size costs into CY17," analyst Ed Maguire wrote in a note.

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Maguire noted that the weak transactional server revenues in the third quarter were due to macro concerns. The analyst said once the cloud adoption increases mix of commercial annuity revenues, the impact will be lessened.

Office365, DynamicsCRM, Azure

Maguire highlighted although momentum in Office365, DynamicsCRM and Azure continues to track well, the economies of scale and top-line growth should be able to offset the lower gross margin cloud business.

"We expect earnings leverage in FY17 to come from top-line growth across the commercial business as the enterprise Windows 10 cycle kicks in in earnest," Maguire noted.

The analyst continued that Microsoft is "expanding the platform ecosystem through Office, Skype, Cortana." Under CEO Satya Nadella, the company is focusing more "on opening up Office as a platform to support more verticalized offerings with partners, along with growing integration with the Dynamics apps business."

"Despite modest revenue contribution, Intelligent Bots are the vehicle for Microsoft analytics and services to be the Azure-powered "intelligence inside" for applications and messaging services running in the Android and iOS device ecosystem," the analyst elaborated.

Pricing Pressure From AWS

In addition, Maguire highlighted that pricing pressure from Amazon.com, Inc. AMZN's Amazon Web Service (AWS) has lessened in recent months, as both companies use their ecosystems for competitive differentiation and advantage.

Office, Windows 10

In addition, the analyst said net growth expectations remain for mid- to slightly-better-than single-digit Office growth and double-digit server growth.

Meanwhile, Windows 10 adoption continues to track well, with over 300 million installs and 83 percent of corporate clients evaluating upgrades.

Maguire expects the corporate upgrade cycle to start in earnest at the end of CY16, with a multi-quarter tailwind driving "upselling and cross-selling incremental products and services."

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Phones

Last week, Microsoft announced an additional phone division restructuring with a $950 million impairment charge, resulting in an 1,850 reduction in staff. Following the sale of feature phone business, Microsoft will be left with "a skeleton crew" in mobile dedicated to corporate targeted devices.

"We believe a 'Surface Phone' will launch in CY17," Maguire added.

The analyst sees EPS of 2.70 for 2016 on revenue of $91.76 billion and $2.95 for 2017 on revenue of $94.38 billion.

At the time of writing, shares of Microsoft were down 0.33 percent to $52.15.