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Microsoft Bets on Startups to Boost Growth

GuruFocus.com
·5 min read

Shares of Microsoft Corporation (NASDAQ:MSFT) are up 34% since March 23. The computing software giant's stock maintained an upward trend for most of the period amid the Covid-19 pandemic.

The company's year-to-date gain of about 15% makes it one of the best-performing stocks among the top five largest technology companies in the U.S.


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With the exclusion of the Saudi Arabia Oil Company (SAU:2222), Microsoft has grown over the last few years to become the world's largest publicly traded stock with a market capitalization of $1.39 trillion. A significant part of this growth can be attributed to the company's mergers and acquisitions activity, which included 20 deals valued at about $9.1 billion in 2019 alone.

The company is heavily investing in disruptive startups with a focus on the internet of things, artificial intelligence and cloud services. Microsoft has also grown its startup partnerships in a bid to gain entry to new markets. Just like tech rivals Amazon.com Inc (NASDAQ:AMZN) and Alphabet Inc. (NASDAQ:GOOG), the world's leading office software maker is looking to diversify its operations in a bid to boost growth.

Microsoft's acquisitions and partnerships are neatly weaved into its expansive business model, which allows the creation of operational synergies. For instance, the company's most recent update on its healthcare bot illustrates how effectively it has integrated AI and IoT into its fabric.

The technology giant has teamed up with Polish healthcare tech startup Infermedica, delivering a top-of-class advanced AI triage engine. Verified by a medical team, Infermedica's toolkit helps reduce unnecessary visits and enables symptom checking in 17 languages. Infermedica also created Symptomate, a free self-diagnostic tool that allows users to pre-diagnose their symptoms before seeking medical advice.

The company's cloud services business is also beginning to peak after signing a $10 billion contract with the U.S. government. The most important thing about this contract, in my estimation, is the precedent it sets for other governments across the world to follow. As many continue to digitize their data, cloud storage and information sharing platforms will become even more important, and Microsoft's Azure cloud services will stand to gain.

In the most recent quarter, the company reported a 27% rise in revenue from the intelligent cloud business. The company said that part of this growth was driven by increased remote work amid the pandemic.

Last year, Microsoft acquired the crowdsourced developer platform GitHub for $7.5 billion. This will again play a crucial part in growing its developer community. GitHub is the world's largest web-based code sharing platform and will continue to run independently. This acquisition will boost the growth of Microsoft's productivity and business processes unit. Currently, GitHub has 1.8 billion businesses and organizations on its platform. The platform also has 80 million repositories and 27 million developers globally. Microsoft's productivity and business processes unit reported revenue growth of 15% in its most recent quarter.

The company is also targeting the dual-screen foldable devices market with its Windows 10X operating system. The Windows OS maker has already released development tools so that developers can begin developing apps for dual-screen devices. Dual-screen devices could form part of the milestones required to take the smart devices market to the next level.

The company's acquisitions of Flipgrid and DataSense in 2018 and 2019, respectively, also play a big part in its bid to invest in the education sector. Flipgrid allows teachers and students to post question and answer videos in a tiled grid. It will help Microsoft to boost its share of the ed-tech market through collaborative learning. On the other hand, DataSense will enable Microsoft to bring more data analytics to educational institutions.

The company also made several gaming-related acquisitions that will boost product offerings via Xbox and user experience.

Valuation

From a valuation perspective, shares of Microsoft appear relatively expensive compared to competitors like Apple Inc. (NASDAQ:AAPL) and Alphabet. This could be partly due to the company's gains in recent quarters. It is now the world's biggest tech company in terms of market capitalization. Its price-earnings ratio of 30.50 is relatively higher than Alphabet's 28.06 and Apple's 24.12. However, it is several levels cheaper than Amazon, which trades at a price-earnings ratio of 115.11 as of the writing of this article.

Amazon's growth potential could be the primary reason behind its premium valuation. When we factor in the expected earnings growth for the next five years, all four companies appear to be about evenly valued. Alphabet's price-earnings-to-growth ratio of 1.97 is the most compelling, followed by Apple's 2.17. Microsoft is again placed third with 2.20, while Amazon has a PEG ratio of 2.22.

Conclusion

In summary, Microsoft appears to be creating a business model that explores diverse markets. It is no longer just a computing software company. This explains why the company has grown so rapidly over the last few years to topple Apple and become the most valuable tech company in the world.

Disclosure: No positions in stocks mentioned.

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This article first appeared on GuruFocus.