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Microsoft Slowly Becoming a SaaS Company

- By Sangara Narayanan

Microsoft Corp.'s (MSFT) valuation has gone up by more than 20% in the last 12 months and the stock price is constantly near 52-week highs. There are several factors behind the new-found momentum of Microsoft stock, including reduced dependency on Windows revenue streams, a surging software-as-a-service portfolio and near triple-digit growth of the company's infrastructure-as-a-service offering, Microsoft Azure.

One major development in the last six months is the technology giant has decided to put all of its muscle behind its SaaS products, Office 365 and Dynamics 365. Microsoft is in an extremely strong position in the office collaboration market. The company recently announced there are 85 million monthly active Office 365 users around the world. The commercial monthly subscription cost per Office 365 user starts at $5 and goes above $30 for enterprise users, suggesting Microsoft is easily making more than half a billion dollars every month.

The important point to note here is Office commercial revenues have been growing above 50% for the past several quarters, with last quarter numbers coming in at 47%. If there was enough competition in the market, such high growth would not be easy to come by; and when you factor in the near 45% margin from by its Productivity and Business Processes segment, it is clear Microsoft has an above-average product with negligible market competition.

Alphabet Inc.'s (GOOG) (GOOGL) Google introduced several improvements to its productivity suite, known as G Suite, during the recent Google Cloud Next conference in San Francisco. Amazon (AMZN) is slowly stepping into the business productivity segment as well, recently having launched Amazon Chime, a Skype competitor.

The competition is slowly getting there, but the problem with productivity applications is users do not like moving to a new application after getting used to the existing one that is already working well for them. In addition, moving an entire company to new productivity tools is a disruptive experience, to say the least.

Although the objective of all collaboration software is essentially the same, products from different companies will have different features and functions. A global team that is familiar with Office 365 would find it extremely difficult to move to a competitor's product because the learning curve will be steep, and let's not forget the cost and difficulty involved in migrating to the new application suite.

With a base of 85 million users (more than one-fourth the size of Twitter's (TWTR) user base), Office 365 is possibly one of the most-used commercial SaaS applications in the world, and it is growing fast. Similar to the lead Amazon has in cloud service, the advantage Microsoft has over competitors in regard to Office 365 will make it extremely hard to compete with.

The fact Microsoft has managed to draw attention away from its Windows licensing revenues to its newer cloud-based revenues alone is proof the company has transitioned nicely into the new growth segment.

The company will still face some cannibalization of revenues - because every new Office 365 customer is one customer lost to its standalone Office application - but the beauty of getting users to subscribe to SaaS applications is Microsoft will now be able to keep adding new functions and services on a regular basis, expanding its portfolio and revenues.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

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This article first appeared on GuruFocus.