Thursday, March 03, 2011

MSFT - did I undershoot growth potential?

Barrons has an article that forecasts PC growth over the next several years at 10%. They are quoting this article. This has big implications for MSFT revenue growth.

I estimated a 4% volume growth in pricing MSFT at $34, does this 10% mean that I was too conservative? Not necessarily, but it is an interesting question.

Microsoft has two different sales targets - pre-installed software and upgrades for computers already in use. The first will generally track computer sales overall - thus if sales increase by 10% we can expect that MSFT products will rise with it.

More difficult to assess is the upgrade market. Slower growth in sales mean more parity between scrappage rates (which are high in a product as disposable as an old computer) and sales rates and thus a more stable installed base. At the same time, the increasing age of the installed base means that opportunities for upgrading within the installed base may increase, suggesting a continued rise in sales.

Unfortunately MSFT does not break this out entirely. The $5bn of revenue - and $3bn in operating profit - from the Windows and Windows Live divisions is likely to increase at near 10% a year, as 75% of revenue comes from pre-loaded software on new PCs. (There was a spike in 2009, reflecting the launch of Windows 7, which increased sales to the installed base significantly as people with Vista or XP upgraded).

MS Office, however, is only broken out into business licenses, (which are usually bulk) and individual licenses. These also grew nicely in 2010, but in no small part because of the introduction of Office 2010. We can expect some decline in sales there into 2012, but overall sales should remain brisk.

MSFT's third major revenue trunk - the Xbox360 is seeing massive growth, primarily from the Kinect, which enables users to be their own controllers. Sales will not continue to grow 55% per year, but a higher installed base should lead to more licensing sales of software going forward.

So, 4% growth may be a bit conservative, but then again, my 2% price increase could be a bit aggressive. Ultimately, I think it means that MSFT is likely to be able to maintain a solid growth rate over the medium term (my estimates for long term growth are around 2%).

Call it some margin of safety, and one more and more gets the sense that MSFT is truly undervalued. Not enough of a growth stock to have an I-Banking / financial media story, and requiring too much CAPX for most hard value investors.

Please tell me why I am wrong.

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