August 3, 2016 – MSFT: An AI-powered Vision for the Future of Enterprise Computing
MSFT’s strength in AI is a considerable weapon as it pursues its 3-part strategy, working from the cloud out and pointing the company toward becoming the dominant force in driving enterprise productivity. 1. Reinvent productivity and business processes – With applications on its cloud, MSFT can use AI to analyze workflows on behalf of customers, identifying high performing teams, best practices, and obstacles to efficiency across their organizations and business ecosystems. We believe that this has huge potential. 2. Build the intelligent cloud platform – AWS leads Azure by a wide margin today, but MSFT is gaining as traditional enterprises look to the cloud. Azure has sufficient scale, but can differentiate with tools to support hybrid applications, data management, and analytics – including AI. 3. Create more personal computing – MSFT plans an AI centered user interface paradigm that can transcend device platforms, including its own Windows, engaging users from the cloud through applications that can work anywhere. We believe MSFT’s current platform dominance in the workplace and SaaS/IaaS/AI leadership gives it an enormous leg up in establishing this new UI approach. These 3 elements – well-integrated suites of smart applications using usage data and AI to guide decision making, a leading hyperscale computing platform with powerful tools to help enterprises transition to the cloud and exploit its myriad benefits, and an intuitive, smart and “frictionless” interface that follows users across platforms – will combine to allow MSFT to target a much, much larger share of enterprise IT spending in the future.
- Nadella’s 3-part strategy. After becoming MSFT CEO in 2014, Satya Nadella issued a new mission – “To empower every person and every organization on the planet to achieve more.” 3 challenges – 1. Reinvent productivity and business processes, 2. Build the intelligent cloud platform; and 3. Create more personal computing – are the reporting structure as well as the planks of the strategy. We believe that these vague tenets, backed by leadership in both cloud hosting and AI (https://www.ssrllc.com/publication/a-deep-learning-primer-the-reality-may-exceed-the-hype/), underlie an audacious play for the next era of enterprise computing that could dramatically expand MSFT’s dominance.
- Leveraging unique assets. MSFT starts with a powerful hand – 1.6B Windows users, 1.2B Office users, a world-class hyper-scale data center infrastructure, long experience and deep expertise in AI technology, and a crack salesforce with relationships with almost every IT organization on Earth. We believe that Nadella’s strategy could use these assets to revolutionize the way that enterprises and their employees work and use information. In this context, the 3 strategic planks take on more meaning.
- Using data to drive productivity. MSFT’s successful transition to the SaaS model for its massive Office franchise, along with the growth of Dynamics, LinkedIn, and other SaaS products, is delivering clear cost and performance advantages to its customers. Longer term, this shift has even larger implications, as the data available by hosting all of this activity on MSFT’s cloud feeding state-of-the-art deep learning systems can yield extraordinary insights for enterprises. Managements will be able to assess organization dynamics – workflows, team and individual performance, sales effectiveness, business process best practices, etc. – with unprecedented clarity, giving MSFT a unique position vs. all rivals in enterprise application software.
- Gaining cloud platform advantage. Cloud hosting is attacking the nearly $1.4T spent annually by enterprises worldwide on their data center operations. At the core are IaaS platforms levering scale and architectural advantages to offer computing and storage capacity with clear performance advantages at a fraction of the cost of private facilities. We believe that MSFT’s Azure is one of only 3 platforms (AMZN, GOOGL) with the scale and capability needed to assure long term success. MSFT’s tight positioning with IT organizations and its emphasis on the needs of traditional enterprises, along with a growing suite of services primed to facilitate migration to the cloud, to support hybrid operations, and to enhance customized development, including AI tools, are and will be key differentiators in an obviously price competitive business.
- Changing the interface paradigm. “More personal computing” is the glibbest of the 3 strategic tenets. For the moment, MSFT’s platforms and devices – Windows, Surface, phones, Xbox, etc. – are reported under the banner, but for the longer term, we believe Nadella has greater ambitions. An AI interface that reaches to any platform bringing coordinated secure access to MSFT’s applications, an enterprise’s own systems, and cloud-based resources could obviate the need for OS control. The interface, perhaps a future version of Cortana, would be an intuitive and personalized tool for accessing needed information and executing tasks, taking input from users in many forms – text, clicks, taps, speech, gestures, eye movement, etc. – and considering context – time, place, other people, schedules, etc. – to respond in the most effective manner, thus driving adoption and usage for MSFT services.
- Advantaged for $1.5T+ addressable market. The productivity/business processes thrust addresses the $330 B application software market. By creating data and interface synergy across applications, MSFT can build traction for its Dynamics ERP, LinkedIn, and BI, and longer term, create unique organizational productivity products that have no analog today. None of its main rivals – ORCL, SAP, CRM, etc. – can counter its cloud infrastructure or AI development capabilities. The competitors for the $1T+ IaaS hosting opportunity, specifically AMZN and GOOGL, may lead MSFT on a cost basis but cannot really leverage existing enterprise relationships. We also see MSFT as better understanding of the real needs of traditional IT shops as they face transition to the cloud. Finally, the market opportunity from UI paradigm change is more difficult to quantify and has obvious rivals in GOOGL, AAPL, and even AMZN. Still, in the enterprise context, we believe Cortana helps to differentiate MSFT applications, build switching barriers, and could be a bridge to the consumer market.
- Expecting acceleration. MSFT’s strategic products – Office 365, Azure, Dynamics, etc. – are driving growth while the slow erosion of the Windows platform creates drag. Still, previous concerns that iOS and Android tablets would displace workplace PCs now appear significantly over blown. We believe that Nadella’s strategic investment will spawn new products – a broader suite of SaaS applications, new platform tools, etc. – that will supplement the existing growth products. We believe that the consensus 8.5% 5yr EPS CAGR can be easily beat as the strategic businesses drive sales acceleration and cost cutting initiatives boost margins. With time, the investment narrative will change to encompass Nadella’s strategic vision and expectations will be revised upward, yielding 40-50% upside to current valuations.