Pacific Crest expects another solid earnings report from Microsoft Corporation (NASDAQ:MSFT) on April 24. Tailwinds should position Microsoft for the highest revenue growth in two years (7% y/y) and the fourth straight quarter of double-digit growth in FCF. Pacific Crest expects Microsoft's cloud strategy to come into full bloom at the Build user conference in Seattle on May 10. The firm remains confident in MSFT as a core Overweight holding.
Several tailwinds should position Microsoft for an acceleration in revenue growth during FQ3 (March). These include robust commercial cloud growth in excess of 40% y/y, the second consecutive quarter of growth in Windows OEM driven by the Win10 commercial refresh cycle, and a full-quarter benefit of LinkedIn that could boost overall revenue growth by ~400 basis points from last year.
Commercial cloud should increase by at least 40% this quarter, exceeding a $14.3 billion annual run-rate. The cloud gross margin will be more dependent on the mix of large deals but could remain in the high-40% range despite Azure price cuts. Microsoft appears comfortably on track to reach its goal of growing its cloud segment to a $20 billion run-rate in 2018. Cloud revenue could approach 20% of sales within the next two years, up from just 5% in early 2015.
Windows OEM licensing could grow for the second straight quarter, up 3% y/y to $2.39 billion (10% of sales). IDC indicated that PC shipments had returned to growth for the first time in five years during Q1.
Microsoft stands to benefit from several upside revenue drivers and product catalysts this year, and could sustain double-digit cash flow growth as margins begin to improve. Pacific Crest’s price target of $70 assumes continued cloud progress can maintain the current EV/FCF multiple, now at ~16x Pacific Crest’s 2017 estimates.