FNCE201 – Corporate Finance (G6)
AY 2021/2022 Term 1
Advanced Valuation Report
Prepared for: Professor Margaret Zhu
Prepared by: Group 5
Name
Student ID
Tan Kian Boon
01367795
Koh Yuan Zhang
01356209
Shaun Seow Guo Feng
01358556
Darren Wong Jun Lin
01356425
Ho Chen Shen
01373925
Xiong Yuyang
01450517
Table of Contents
1.
Introduction ..........................................................................................................................1
1.1
Company Overview ........................................................................................................2
1.2
Industry Overview ..........................................................................................................3
1.3
Acquisition and Partnership............................................................................................4
2.
Capital Structure ...................................................................................................................4
3.
Estimating Equity Beta ..........................................................................................................5
3.1
Capital Asset Pricing Model ............................................................................................5
3.2
Company Comparable Analysis .......................................................................................5
3.3
Dividend Discount Model ...............................................................................................6
4.
Possible Estimation Error .......................................................................................................7
5.
Valuation ..............................................................................................................................7
5.1
Dividend Discount Model ...............................................................................................7
5.2
Discount Cash Flow Model ..............................................................................................8
5.3
Relative Valuation ........................................................................................................ 10
6.
Risk associated with Microsoft ............................................................................................ 11
7.
Recommendations .............................................................................................................. 11
8.
Sources ............................................................................................................................... 12
9.
Appendix............................................................................................................................. 13
SWOT Analysis ..................................................................................................................... 15
Strength ................................................................................................................................. 15
Weakness............................................................................................................................... 15
Opportunities ........................................................................................................................ 15
Threats .................................................................................................................................. 15
1. Introduction
Microsoft Corporation (NASDAQ: MSFT) is a technology company that transforms businesses to lead
in the new era of intelligent cloud and intelligent edge. In 2021, Microsoft Corporation generated over
USD 168 Bn of sales and grew 18% from the previous year. We believe that Microsoft Corporation
should have a Strong BUY rating with a potential upside of 13% due to the following reason:
1. Strong Natural Growth Drivers Favouring Microsoft’s Revenue Generating Products

Intelligence Cloud Segment (Azure and Microsoft Cloud Services) – We believe that with the appeal
of cloud computing to a variety of businesses and increased adoption rates will help ensure that
Microsoft, being the second largest provider of Cloud Infrastructure, will continue to experience
demand for their products and sustained growth. By 2021, 73% of organizations will be using all or
mostly cloud solutions. Nearly 85% of small companies have already invested in cloud options (Luxner,
2021). With 95% of Fortune 500 companies now using Azure, this highlights a dominant and growing
position Microsoft can credit to decades of trust built upon major corporation reply on their Windows
Operating Systems and Servers (Kindig, 2020).

More Personal Computing Segment - Gaming going Digital – Microsoft revolutionized the Gaming
Industry with their Game Pass, which is like a Netflix for Xbox, allowing gamers downloads from an
extensive digital library of games for a monthly fee (Microsoft, 2021). This is a competitive edge over
their biggest rivals Sony within the Gaming Industry and has shown promise, with 23 million
subscribers since January 2021. With their growth in the Gaming Industry likely to Digital and
Subscription based, Microsoft is positioned to profit and grow from increased margins and valuable
recurring subscriptions (Weldon, 2021).

Productivity and Business Processes Segment (LinkIn) - Microsoft also has a promising future
with LinkedIn, their largely unmonetized professional social network. Within the rapidly
changing digital economy, people are increasingly needing a platform where they can acquire
new skills, expand their network, and connect with employers. Today, LinkedIn has more than
774 million members and is a leader in B2B advertising, corporate learning, and professional
hiring. The advertisement revenue generated by LinkedIn in 2020 increased by over 60%,
generating $3 billion in revenue. In addition, unlike YouTube or Medium, LinkedIn still does
not pay for views. A direct monetization system on LinkedIn would lead to a rapid influx of
traffic, which would lead to substantially higher advertisement revenue (Hempel, 2017).
2. Competitive Advantage Protecting Microsoft From Rivals
1

Microsoft is essentially the landlord of technology as much of the world’s technology depends on the
systems for a place to live and work. Microsoft possess a wide competitive moat (Downie, 2021).
Switching costs, which include factors like time lost retraining a workforce on new software, translate
to a significant competitive advantage for Microsoft. Additionally, although Teams is a free product, it
contributes to Microsoft's competitive moat by introducing users to the Microsoft 365 software suite,
which makes up 22% of the company's total revenue with higher margins than its traditional software
sales, and encouraging paid upgrades for security, additional storage, and collaboration with other
Microsoft apps. Their ecosystem of mutually reinforcing products not only discourages users from
switching to competitor products, and also helps Microsoft build a long-term customer base.

Lucrative Contract Deals serve to strengthen Microsoft’s competitive advantages by reducing
capital requirements, granting Microsoft greater financial resources to extend their economic
moats, reducing financial risk at the same time. Microsoft has secured a contract worth $10
billion to provide Cloud Services for the US Department of Defence, beating out Amazon. In
addition, they secured another contract to outfit the US army with AR headsets worth $22
billion (Microsoft Annual Report, 2021).
3. Strong Leadership

Ever since Nadella’s Leadership, shares of Microsoft have more than doubled. Their share
price grew by 327% since he took over, evening beating Apple’s 212% increase by a significant
margin (Miller, 2019). Nadella's tenure has been characterized by a return to Wall Street
prominence, outperformance, revenue diversification and his biggest theme: Cloud Computing.
Microsoft is primed to experience more growth under Nadella’s watchful leadership
1.1
Company Overview
Microsoft Corporation is the world’s largest software maker with a market capitalisation of USD 2.5
trillion that transforms businesses to lead in the new era of intelligent cloud and intelligent edge
(Bloomberg, 2021). Its revenue can be divided into three parts: Intelligent Cloud (IC), Productivity
and Business Processes (PBP), and More Personal Computing (MPC). In terms of market share,
Microsoft dominates the PC operating systems and office tools and is also a top 3 leading company in
the cloud computing industry (Dignan, 2021).
In 2021, Microsoft achieved sales of USD of 168 billion, an 18% growth from the previous year and
a 13% CAGR from 2016 in Appendix Figure 1 and 3. It also has relatively equal revenue generated
from each of the 3 segment as seen in Appendix Figure 2, with 32% of the revenue constituted from
personal computing, 36% from intelligent cloud, and 33% from productivity and business processes.
2
It also has one of the most robust balance sheets in the world. The company currently has around USD
130 billion in cash and short-term investments, with the total assets of about USD 258 billion. It also
has an efficient inventory turnover as shown in Appendix Figure 4. Microsoft’s EBIT and Gross
Margin has also been increasing consistently since 2015 showing improvements in operation
efficiency shown in Appendix Figure 5. It also has consistent return on assets and equity as seen in
Appendix Figure 6.
The transformation of Microsoft from an OS (Windows) and Office software company to one of the
leading companies in the cloud computing industry is one of the biggest factors that contribute to the
change of Microsoft’s fortunes. Ever since the new CEO, Mr Satya Nadella took over in 2015,
Microsoft’s culture was transformed and embraced newer options to increase business moats.
Once known as the face of Windows OS (MPC) and Microsoft Office (PBP), the company added
Azure (IC) as the third big brand name of its portfolio. Under Nadella leadership, Azure aggressively
expanded in the IC and PBP businesses. Microsoft radically modified its offering so that new and
existing products can seamlessly transit to its Azure cloud platform. Even Office and Windows
products are available for use on cloud. Azure and Office 365 provided an open use ecosystem with
all the Microsoft products that led to the IC and PBP business aggressive expansion. Microsoft has
successfully transformed its business from devices-based computing (Microsoft Operating System) to
cloud computing. The platforms and products are also open source as opposed to being closed
development in the past, which helps to promote new products being built upon Microsoft. It has also
successfully switched from a one-time payment to a subscription-based model.
1.2
Industry Overview
The software industry can be broken down
to three main segments, namely: Software
as a Service, Platform as a service, and
infrastructure as a service. Microsoft is the
market leader in the software as a service
as a service and platform as a service
segment. These segments consists of the
MS Office product suites and other
business software, which the majority of
the companies in the world have been
using for decades.
3
1.3
Acquisition and Partnership
Microsoft has also acquired many companies in various fields over the last few years. Two of their
biggest acquisition are LinkedIn and GitHub. According to their annual report (2021), they are also in
the midst of acquiring Nuance Communications, a platform which aims to improve the patient
experience and reduce overwhelming burden of work faced by doctors by providing ambient clinical
intelligence capabilities for healthcare organizations. They also recently completed the acquisition of
ZeniMax media which creates great content to drive Microsoft’s Xbox game pass growth. Such
acquisition and partner makes Microsoft a great company
2. Capital Structure
As of FY2021, Microsoft has a market capitalisation of approximately USD 2.5 trillion with a total
debt of USD 78 billion. It has a debt-to-equity ratio of 3% indicating low financial leverage. Microsoft
relies more heavily on equity than debt for financing. Microsoft also has USD 131 billions of cash and
equivalents, and short-term assets. This means that Microsoft has enough cash on hand to pay off their
debt. Looking at their equity over the years, they have also been consistently repurchasing their shares
from 2017 to date. Just recently on 29 Sep, they announced a USD 60 billion share buyback and also
raised dividends (Microsoft News Centre, 2021).
A closer look at Microsoft debt capital which includes short term and long-term debt also revealed that
Microsoft have significantly reduced its amount of short-term debt. They have paid off their shortterm debt of USD 13.2 billion as of 2016 in 2018. Microsoft have also increasingly use debt to finance
acquisition of companies to grow their ecosystem for users. It acquired LinkedIn for more than USD
26 billion in 2016. In their Annual Report (2021), they also announced that they are in the midst of
acquiring Nuance Communication with an expected closing date by the end of the year to provide
ambient clinical intelligence capabilities for healthcare organizations, and to improve the patient
experience and reduce the overwhelming burden of work that physicians struggle with today. We
foresee that Microsoft will take on some more debt to finance the impending acquisition to also take
advantage of the low interest rate environment.
Microsoft utilisation of low debt and high equity capital structure provides it with several advantages.
Debt financing also does not have voting preferences, which is useful for accelerating Microsoft
expansion without diluting the shareholder’s equity. It also allows Microsoft to take advantage of
interest tax shields which will improve their earnings per share. We expect Microsoft to use debt
4
financing to acquire more companies like Nuance Communication as the FED increases interest rates
due to rising inflation.
3. Estimating Equity Beta
3.1
Capital Asset Pricing Model
Using 5 years of data for Microsoft, S&P 500, and 10-year US T-bill, we regressed Microsoft returns
against the Market Returns to obtain a beta (β) of 0.824 and an intercept (α) of 0.02. An adjusted R
square of 0.5306 indicates that only 53.06% of Microsoft's risk premium is explained by the market
and implies the presence of other factors that might contribute to returns of Microsoft. The T-Stat of
intercept (α) and beta (β) is 3.81 and 8.22 and low p-value shows that both the intercept (α) and beta
(β) are statistically significant, and data are reliable. We then calculated the cost of equity to be 5.51%
using the beta of 0.82 calculated from regression, a market risk premium of 4.75% (Damodaran, 2021),
and the yield of the 10-year treasury bill of 1.60%. Next, we calculated the cost of debt by estimating
the debt beta to be 0.05 because Microsoft has a credit rating of AAA from S&P. We also assumed an
effective tax rate of 17% for Microsoft, to get a post-tax cost of debt of 1.53%. Finally, we calculate
the WACC to be 5.38% by multiplying the cost of equity and post-tax cost of debt with a D/E ratio of
3.39% (Refer to Figure 7).
Estimating Microsoft Beta Using CAPM
Cost of Equity
Risk Free Rate
Market Risk Premium
5 year Beta (Historical Monthly)
Cost of Equity
WACC Calculation
1.60%
4.75%
0.83
5.53%
Cost of Debt
Risk Free Rate
Market Risk Premium
Beta of Debt
Cost of Debt
Effective Tax Rate (Historical Average)
After-tax Cost of Debt
1.60%
4.75%
0.05
1.84%
17%
1.53%
Date
Share Price
Number of Shares Outstanding (Basic)
Market Capitalisation
Total Debt
D/E Ratio
Proportion of Equity Capital
Proportion of Debt Capital
Weighted Average Cost of Capital (Post Tax)
Weighted Average Cost of Capital (Pre Tax)
26/10/21
310.13
7.508
2328.46
78.94
3.39%
96.7%
3.3%
5.40%
5.51%
Figure 7: Calculating WACC using CAPM
3.2
Company Comparable Analysis
The second method that we used to estimate the beta is the Company Comparable Analysis. We
attempt to look for relevant competitors in the industry using Capital IQ quick comparable function
Then, we obtain the market capitalisation, total debt, and beta of the comparable companies, un-lever
5
the beta for each company, get the average beta, then re-lever to Microsoft current D/E ratio to obtain
its beta of 1.04 shown in Figure 8.
Estimating Microsoft Beta using comparable companies
Company
Market Capitalisation
Salesforce.com, inc. (NYSE:CRM) $
288,913
VMware, Inc. (NYSE:VMW)
$
66,196
Alphabet Inc. (NasdaqGS:GOOG.L) $
1,854,233
ServiceNow, Inc. (NYSE:NOW)
$
134,080
Amazon.com, Inc. (NasdaqGS:AMZN)
$
1,709,779
Adobe Inc. (NasdaqGS:ADBE)
$
305,702
Apple Inc. (NasdaqGS:AAPL)
$
2,468,284
Microsoft
$
Total Debt
$ 15,774
$ 6,080
$ 28,109
$ 2,227
$ 136,238
$ 4,685
$ 136,522
D/E Levered Equity Beta (5 year) Unlevered Equity Beta(5 year) Debt Beta
5.5%
1.04
1.00
0.05
9.2%
0.89
0.83
0.06
1.5%
1.03
1.02
0.05
1.7%
0.94
0.93
0.05
8.0%
1.16
1.09
0.05
1.5%
1.03
1.02
0.05
5.5%
1.22
1.17
0.05
Average Beta
1.01
0.05
2,328,456 $ 78,935 3.4%
Relevered Beta
1.04
0.05
Figure 8: Calculating WACC using Comparable Companies
After that, we used the re-levered beta of Microsoft to calculate the cost of Equity to be 6.54%. As for
the cost of debt, we estimate the debt beta to be 0.05 because Microsoft has a credit rating by S&P of
AAA. Using their debt beta, a market risk premium of 4.75% (Damodaran, 2021), the yield of the 10year treasury rate of 1.6%, their cost of Debt is calculated to be 1.53% (assuming 17% effective tax
rate). With the cost of equity and cost of debt calculated, we calculate the WACC to be 6.21%.
3.3
Dividend Discount Model
The third method used for estimating the beta
is the Dividend Discount Model. Microsoft
has announced quarterly dividend of $0.62 for
Q1 of 2022. We project that they will give out
the same dividend for the remaining quarters
of 2022. This will amount to an annual
dividend of $2.48 for FY2022. To estimate
the beta for Microsoft using DDM, we obtain
the dividends paid by Microsoft for the last 10
years using Capital IQ and calculated the YOY growth rate. Then we find the arithmetic and geometric
growth rate of the dividends. Using its price per share of $313.11 as of 26 Oct 2021, and the expected
2022 dividend of $2.48 with the geometric growth rate of 14%, we calculated the cost of equity to be
15%. Then we calculate the cost of debt using the same method as the other 2 methods to be 1.53%.
We calculate the WACC to be 14.06% shown in Figure 9.
6
4. Possible Estimation Error
There are 4 possible error estimates which will affect Microsoft’s cost of equity and WACC. Firstly,
different people may select different indices to compare against Microsoft because they believe that
the other index is a better representation of the overall portfolio. However, there is no indices that
really measure the overall market portfolio. Using a different market index will result in different betas
for Microsoft, which could lead to over or under-estimate of Microsoft’s cost of equity and WACC.
The S&P500 is a good index to use to measure the overall market portfolio because it is the weighted
average return of a subset of large capitalization equities in the overall market. Secondly, the time
period of the returns that we choose also affects the estimation of our beta. Using a shorter period will
give a higher beta due to changing economic conditions. Hence, it is industry practice to use a 5-year
period for the returns (the t-test will tell us if there is a significant difference between the market and
stock returns). This would provide more observations and improves the regression model when
calculating the beta. Thirdly, the estimation of the beta for Microsoft are historical estimates of the
stock returns for the past 5 years. Historical performance may not be an accurate representation of
future performance. Microsoft may acquire new companies to grow their business or divest their
business for strategic purposes, competitors may capture Microsoft market shares, or the market might
be hit with a recession or pandemic like COVID-19. Therefore, the regressed beta and calculated
WACC may not be predictive of future performance. Lastly, the method which we used to estimate
the beta of Microsoft. Based on our analysis, DDM is not a good method of estimating the beta of
Microsoft because it assumes that the only value of a stock is its return on investment it provides
through its dividends. Furthermore, there are not many companies that issues dividends as they days
prefer to focus on growing the business organically so that their stock price will appreciate.
5. Valuation
Our team performed Relative Valuation from company comparable, discounted cash flow, as well as
Dividends Discount methodology to arrive at Microsoft’s implied share price.
5.1
Dividend Discount Model
Microsoft has been issuing dividends since 2003 and they also recently increased their quarterly
dividends to 0.62 cents per share from 0.56 cents. We attempt to calculate the implied share value of
Microsoft by forecasting its future dividends with a constant growth rate of 10% and terminal growth
rate of 4.50% and discounting it to present value with the WACC of 5.40% calculated using CAPM.
We calculated the implied share price of Microsoft to be USD $352.58 per share. For the dividend
7
discount model, we will assume that the company will continue to issue and increase their dividends
per share regardless of the economic climate.
Share Price as of 26 October 2021
Number of Shares
Market Cap
Total Debt
D/E Ratio
Beta
Market Risk Premium
Risk Free Rate
Cost of Equity
Cost of Debt
Tax Rate
After Tax Cost of Debt
WACC (Post Tax)
WACC (Pre Tax)
Terminal Growth Rate
Dividend Discount Model
Year
Dividends per share per year
Growth Rate
Discount Factor
Present Value of Future Dividends
Terminal Value
PV of Terminal Value
Implied Enterprise Value
Add Cash
Less Debt
Implied Equity Value
Number of Shares
Implied Share Price
$
$
310.13
7.508
2,328
78.94
3.39%
0.83
4.75%
1.60%
5.53%
1.84%
16.8%
1.53%
5.40%
5.41%
4.70%
2016
$ 11,006
USD
Billion
Billion
Billion
(Beta calculated from regression of Market and Stock Returns)
(Country Equity Risk Premium by Damodaran)
(Yield of the 10-year US Treasury Bill)
(According to Calculations from CAPM)
(Based on a Debt Beta of 0.05 for Microsoft Credit rating of AAA)
(According to CIQ Estimates)
2017
$ 11,845
7.6%
2018
$ 12,699
7.2%
2019
$ 13,811
8.8%
2020
$ 15,137
9.6%
2021
$ 16,521
9.1%
1
2
3
4
5
Projected Projected Projected Projected Projected
2022
2023
2024
2025
2026
$ 18,173 $ 19,990 $ 21,989 $ 24,188 $
26,607
10.0%
10%
10%
10%
10%
0.95
0.90
0.85
0.81
0.77
$ 17,243 $ 17,996 $ 18,782 $ 19,602 $
20,458
$ 3,229,965
$ 2,483,490
$ 2,577,570
$ 130,256
$
78,935
$ 2,628,891
7508
$
350.15
Figure 10: Dividend Discount Model for Microsoft
5.2
Discount Cash Flow Model
Our performed a DCF Model to calculate the implied share price of Microsoft. For our revenue
assumptions, we divided Microsoft’s revenue into the 3 different segments: Processes and Business
Productivity, Intelligent cloud, and More Personal Computing. We assumed a the growth rate below
for PBP, IC, and MPC respectively for the next 5 years. Our group believes that that Microsoft is wellpositioned to benefit from the growth of the cloud computing industry due to continue adoption of its
azure cloud infrastructure platform, cloud-based office 365 productivity suite, and more profitable
games in Xbox. For our optimistic scenario, we assumed a 20% increase from the current growth rate
as shown in our excel sheet. For our conservative scenario, we assumed a 10% decrease from the base
scenario.
Figure 11: Revenue Assumptions for Microsoft DCF
Revenue Assumptions
Productivity and Business Processes
Intelligent Cloud
More Personal computing
Revenue Growth rate
2017 2018 2019 2020 2021 2022 F 2023 F 2024 F 2025 F 2026 F
16% 20% 15% 13% 16%
20%
20%
18%
18%
16%
10% 18% 21% 24% 24%
27%
27%
25%
24%
23%
-3%
8%
8%
6% 12%
20%
20%
18%
18%
15%
- 14% 14% 14% 18%
23%
23%
21%
20%
19%
Below are our assumptions for the Microsoft expenses. We assumed cost of goods sold (COGS) and
operating expenses (OPEX) as a percentage of revenue earned. There are two main operating expense
for Microsoft, R&D expenses, and SG&A expenses. For simplicity, we did not divide them. We also
forecast the depreciation and amortization, as well as capital expenditure for the next 5 years as a
8
percentage of the revenue earned. We assumed there are no change for the operating assumptions for
different scenario.
Figure 12: Operating Assumptions for Microsoft DCF
Other Assumptions
COGS
OPEX
D&A
CAPEX
Net Income Margin
2017 2018 2019 2020 2021 2022 F 2023 F 2024 F 2025 F 2026 F
35% 35% 34% 32% 31%
30%
30%
30%
30%
30%
34% 33% 32% 31% 27%
26%
26%
26%
26%
26%
8%
9%
9%
9%
6%
7%
7%
7%
7%
7%
8% 11% 11% 11% 12%
11%
11%
11%
11%
11%
26% 15% 31% 31% 36%
36%
36%
36%
36%
36%
These are our following assumptions for Microsoft’s working capital. We used a 3-year average for
their receivables, inventory, other current assets, and payables. Then we calculate the change in NWC
in Figure XX.
Figure 13: Working Capital Assumptions and Calculations
Working Capital Assumptions
Receivables
Inventory
Other Current Assets
Payables
Working Capital Analysis and Projections
Receivables
Inventory
Other current assets
Payables
Net Working Capital
Change in NWC
Receivables T/O
Days Receivables Outstanding
Payables T/O
Days Payables Outstanding
Cash Conversion Cycle
2017
23%
2%
5%
8%
2018
24%
2%
6%
8%
2019
23%
2%
8%
7%
2020
22%
1%
8%
9%
2021
23%
2%
8%
9%
2022 F
23%
2%
8%
8%
2023 F
23%
2%
8%
8%
2024 F
23%
2%
8%
8%
2025 F
23%
2%
8%
8%
2026 F
23%
2%
8%
8%
2016
2017
$ 18,277
22431
$ 2,251
2181
$ 6,091
5183
$ 6,898 $ 7,390
$ 19,721 $ 22,405
$ 2,684
4
85
5
79
164
2018
$ 26,481
$ 2,662
$ 6,855
$ 8,617
$ 27,381
$ 4,976
4
88
4
82
170
2019
$ 29,524
$ 2,063
$ 10,133
$ 9,382
$ 32,338
$ 4,957
4
86
5
80
165
2020
$ 32,011
$ 1,895
$ 11,517
$ 12,530
$ 32,893
$
555
4
82
4
99
181
2021
$ 38,043
$ 2,636
$ 13,471
$ 15,163
$ 38,987
$ 6,094
4
83
3
106
189
2022 F
$ 47,000
$ 3,111
$ 16,555
$ 17,322
$ 49,344
$ 10,357
4
83
4
102
186
2023 F
$ 57,620
$ 3,814
$ 20,295
$ 21,236
$ 60,493
$ 11,149
4
83
4
102
186
2024 F
$ 69,539
$ 4,603
$ 24,494
$ 25,629
$ 73,007
$ 12,514
4
83
4
102
186
2025 F
$ 83,715
$ 5,541
$ 29,487
$ 30,854
$ 87,890
$ 14,883
4
83
4
102
186
2026 F
$ 99,262
$
6,570
$ 34,963
$ 36,584
$ 104,212
$ 16,322
4
83
4
102
186
For our WACC, we used the WACC calculated
using CAPM to determine the fair value of
Microsoft. The PV of unlevered free cash flow
was calculated using post-tax WACC of 5.40%.
Then we assumed a 2% terminal growth rate for
Microsoft and discount it with WACC to get the
PV of the terminal value. We add the PV of the
terminal value with the PV of unlevered free cash flow discounted using the post-tax WACC to get
the firm implied enterprise value. Next, we less debt and add cash to get the implied equity value and
divide by the number of shares to get the implied share price of Microsoft. Microsoft is expected to
have an implied share price of $348.75 for base case, $373.96 for our optimistic case, and $324.97 for
our conservative case in Fig 15.
Next, we conducted sensitivity analyse for all 3 scenarios to observe the sensitivity of the share price
to changes to the terminal growth rate and weighted average cost of capital as shown below. Please
9
refer to appendix for the sensitivity analysis for Optimistic and conservative case in Figure 17 and 18
respectively.
Sensitivity Analysis (Base Case)
Year
Unlevered FCF
PV of Unlevered FCF
Implied Share price
Less Debt
Add Cash
WACC
Terminal Value
$
$
1
2022
55,974 $
53,108 $
2
2023
70,214 $
63,207 $
3
2024
85,680 $
73,181 $
4
5
2025
2026
103,328 $ 123,842
83,736 $ 95,222
$ 348.75
78935
130256
5.40%
2.00%
Sensitivity Analysis for Base Case
WACC
$
348.75
0.50%
1.00%
1.50%
2.00%
2.50%
Terminal Growth Rate
$
$
$
$
$
4.38%
335.46
378.12
435.58
517.15
642.03
$
$
$
$
$
4.88%
291.47
323.01
363.88
418.92
497.06
$
$
$
$
$
5.38%
256.87
280.90
311.13
350.28
403.02
$
$
$
$
$
5.88%
229.02
247.78
270.81
299.77
337.29
$
$
$
$
$
6.38%
206.19
221.11
239.08
261.16
288.92
Figure 16: Sensitivity Analysis for the Base Case
5.3
Relative Valuation
Lastly, we select companies with similar market capitalization and competitors of Microsoft in the
intelligent cloud and software operating system space. Next, we applied the multiples of the
comparable companies LTM TEV to EBITDA and Price to Earnings Ratio to sense check our target
price as seen below.
Company Comp Set
Company Name
Alphabet Inc. (NasdaqGS:GOOG.L)
Amazon.com, Inc. (NasdaqGS:AMZN)
Apple Inc. (NasdaqGS:AAPL)
LTM Gross Margin %
56.5%
41.3%
41.8%
LTM Earnings
69103.25369
29075.54163
84530.4611
LTM EBITDA TEV/EBITDA LTM - Latest
85,197.0
19.7x
60,404.0
26.1x
120,233.0
21.7x
P/Diluted EPS Before Extra LTM - Latest
26.8x
58.8x
29.2x
Summary Statistics
High
Low
Mean
Median
75th percentile
LTM Gross Margin % Market Capitalisation LTM Earnings
56.5%
2,468,284.40 $
84,530
41.3%
1,709,778.60 $
29,076
46.5%
2,010,765.47 $
60,903
41.8%
1,854,233.40 $
69,103
56.5% $
2,468,284 $
84,530
LTM EBITDA TEV/EBITDA LTM - Latest
$
120,233
26.10
$
60,404
19.70
$
88,611
22.50
$
85,197
21.70
$
120,233
26
P/Diluted EPS Before Extra LTM - Latest
58.80
26.80
38.27
29.20
58.80
Microsoft
68.9%
Market Capitalisation
1,854,233.4
1,709,778.6
2,468,284.4
$
2,328,306
$
67,098
$
85,745
25.9x
30.7x
Figure 19: Relative Valuation for Microsoft
If we look at the price to earnings per share
of the comparable, the implied share price
projected from DCF is somewhere near the
implied price derived from the multiples for
P/E multiple. This tells us that the market is
also projecting Microsoft to do well.
10
6. Risk associated with Microsoft
Microsoft faces risk and competition from several sectors due to their growing diverse range of
business models, management and governing law surrounding the industry.
Cloud-Based and Operating Systems Competition
With the primary revenue of Microsoft coming from licences of Windows operating systems on PC as
well as cloud-based computing. There is significant risk from substitute products such as tablets,
phones, consoles, and wearables eating up the industry market share. This can be mitigated by
exploring different emerging sectors we can tap into to diversify our product suite to not purely rely
on our cloud-based or operating system as our primary business model.
Scaling, Managerial, JV, and Acquisition Risk
With a huge suite of products under the Windows line, Microsoft faces many scaling and managerial
risk. In addition, acquisitions can also cause unsatisfactory returns. For instance, Microsoft acquired
GitHub, ZeniMax Media, and Nuance Communications since 2018. These strategic alliances bring
about significant risks and challenges; integrating and retaining new employees, management issues
and may result in dissolvement or adverse effects on financial statements. This can be mitigated by
ensuring we do our due diligence on the company we are acquiring, with regard to their culture,
working model, financing, and managerial systems.
Intellectual Property & Privacy Risk
In the data-driven world today, combating piracy and navigating through intellectual property and
patent laws are also a prevalent problem for Microsoft. Third party competitors might be able to copy
functionality if the source code of detailed program commands gets leaked. This can be mitigated by
working closely with authorities, government, and regulatory companies to ensure we are compliant
and protected over our legal and intellectual property rights.
7. Recommendations
Based on our DCF valuation, we would recommend a Strong buy on Microsoft with a base target
price of $313.11, representing a potential upside of 30%. Our team believe that Microsoft is wellpositioned to benefit from the growth of the cloud computing industry due to continue adoption of its
azure cloud infrastructure platform, cloud-based office 365 productivity suite, and more profitable
games in Xbox. This coupled with the strong and consistent management team led by CEO, Mr Satya
Nadella, with the right strategic outlook, Microsoft is poised to do well in the next 5 years.
11
8. Sources
Luxner, T., (2021). Cloud Computing Trends: 2021 State of the Cloud Report. Retrieved from
https://www.flexera.com/blog/cloud/cloud-computing-trends-2021-state-of-the-cloud-report/
Kindig, B., (2020). Forbes. Google Cloud Will Not Be Able To Overtake Microsoft Azure. Retrieved from
https://www.forbes.com/sites/bethkindig/2020/12/03/google-cloud-will-not-be-able-to-overtake-microsoftazure/?sh=736e970b5af9
Microsoft. (2021). Annual report. Retrieved from https://www.microsoft.com/investor/reports/ar21/index.html
Hempel, J. (2017). Wired Magazine. Now We Know Why Microsoft Bought LinkedIn. Retrieved from
https://www.wired.com/2017/03/now-we-know-why-microsoft-bought-linkedin/
Miller, R. (2019). Tech Crunch. Competitive Advantage Protecting Microsoft From Rivals. Retrieved from
https://techcrunch.com/2019/02/04/after-5-years-microsoft-ceo-satya-nadella-has-transformed-more-than-thestock/
Bloomberg. (2021). Microsoft. Retrieved from https://www.bloomberg.com/profile/company/MSFT:US
Weldon, T (2021) 3 Reasons Microsoft Is Not Done Growing Retrieved From 3 Reasons Microsoft Is Not
Done Growing | The Motley Fool
Dignan, L., (2021). Top cloud providers in 2021: AWS, Microsoft Azure, and Google Cloud, hybrid, SaaS
players. Retrieved from https://www.zdnet.com/article/the-top-cloud-providers-of-2021-aws-microsoft-azuregoogle-cloud-hybrid-saas/
12
9. Appendix
Key Financial Highlights for FY 2021
Commercial cloud revenue increased 34% to $69.1 billion
Office Commercial products & cloud services revenue
increased 13% driven by Office 365 Commercial growth
of 22%
Office Consumer products and cloud services revenue increased
10% and Microsoft 365 Consumer subscribers increased to 51.9
million.
LinkedIn revenue increased 27%.
Dynamics products and cloud services revenue increased 25%
driven by Dynamics 365 growth of 43%.
Server products and cloud services revenue increased
27% driven by Azure growth of 50%.
Windows Commercial products and cloud services revenue
increased 14%.
Xbox content and services revenue increased 23%.
Search advertising revenue, excluding traffic acquisition costs,
increased 13%.
Surface revenue increased 5%.
Windows original equipment manufacturer licensing (“Windows
OEM”) revenue increased slightly.
Microsoft’s Financials
Revenue and Revenue Growth Rate
180.0
CAGR of 13% from 2016 to 2021
160.0
14%
140.0
Revenue Segment (In Billions)
20%
18%
14%
100%
18%
16%
14%
14%
120.0
80%
44%
41%
38%
36%
34%
32%
28%
29%
31%
34%
36%
27%
28%
31%
32%
33%
32%
32%
2016
2017
2018
2019
2020
2021
60%
12%
100.0
10%
80.0
8%
6%
60.0
6%
40.0
4%
20.0
2%
0
0%
2017
40%
2018
2019
2020
2021
Figure 2: Microsoft Revenue and Revenue Growth
20%
0%
Productivity and Business Processes
More Personal computing
Figure 3: Microsoft Revenue Segment (In billions)
Growth in Revenue, Gross Profit and EBIT
180,000
Intelligent Cloud
Strong Cash Flow and Efficient Turnover
168,088
$140,000
120
143,015
150,000
125,843
90
110,360
120,000
91,154
$120,000
96,571
60
90,000
$100,000
60,000
30
30,000
$80,000
2016
2017
Revenue
2018
Gross Profit
2019
EBIT
2020
2021
2016
Days Inventory
2017
2018
Days Receivable
2019
2020
Days Payables
2021
Cash
13
Figure 4: Growth in Revenue, Gross Profit and EBIT
Figure 5: Strong Cash Flow and Efficient Turnover
Consistent Returns on Assets and Equity
Consistent Gross Profit and EBIT Margins
Gross Margin
Return on Assets
EBIT Margin
100%
80%
64%
65%
68%
66%
65%
30%
2016
2017
37%
14%
15%
2019
2020
29%
18%
20%
38%
32%
29%
38%
20%
47%
30%
43%
40%
77%
69%
58%
60%
40%
Return on Equity
50%
11%
10%
6%
10%
20%
0%
2018
2019
2020
2021
2016
Figure 6: Increasing EBIT and Gross Profit Margin
Year
Productivity and Business Processes
Intelligent Cloud
More Personal computing
Total Revenue
COGS
Gross Profit
Gros Profit Margin
OPEX
EBITDA
EBIT
Effective Tax rate
Less Taxes
Net Operating Profit After Taxes
Add Depreciation & Amortization
Less CAPEX
Less NWC
Unlevered FCF
$
$
$
$
$
$
$
$
$
$
$
$
$
$
2017
29,870
27,407
39,294
96,571
34,261
62,310
65%
(32,979)
37,131
29,331
15%
4,328
25,003
7,800
8,129
2,684
2018
$ 35,865
$ 32,219
$ 42,276
$ 110,360
$ 38,353
$ 72,007
65%
$ (36,949)
$ 44,958
$ 35,058
55%
$ 19,130
$ 15,928
$ 9,900
$ 11,632
$ 4,976
$ 9,220
2017
2018
2021
Figure 7: Consistent return on Asset and Equity
2019
$ 41,160
$ 38,985
$ 45,698
$ 125,843
$ 42,910
$ 82,933
66%
$ (39,974)
$ 54,559
$ 42,959
10%
$ 4,374
$ 38,585
$ 11,600
$ 13,925
$ 4,957
$ 31,303
2020
$ 46,398
$ 48,366
$ 48,251
$ 143,015
$ 46,078
$ 96,937
68%
$ (43,792)
$ 65,445
$ 53,145
17%
$ 8,773
$ 44,372
$ 12,300
$ 15,441
$
555
$ 40,676
2021
$ 53,915
$ 60,080
$ 54,093
$ 168,088
$ 52,232
$ 115,856
69%
$ (45,940)
$ 80,816
$ 69,916
14%
$ 9,667
$ 60,249
$ 10,900
$ 20,622
$ 6,094
$ 44,433
2022 F
$ 64,698
$ 76,302
$ 64,912
$ 205,911
$ 61,773
$ 144,138
70%
$ 53,537
$ 105,015
$ 90,601
17%
$ 15,257
$ 75,344
$ 14,414
$ 23,426
$ 10,357
$ 55,974
2023 F
$ 77,638
$ 96,903
$ 77,894
$ 252,435
$ 75,730
$ 176,704
70%
$ 65,633
$ 128,742
$ 111,071
17%
$ 18,660
$ 92,411
$ 17,670
$ 28,719
$ 11,149
$ 70,214
2024 F
$ 91,612
$ 121,129
$ 91,915
$ 304,656
$ 91,397
$ 213,259
70%
$ 79,211
$ 155,375
$ 134,049
17%
$ 22,520
$ 111,528
$ 21,326
$ 34,660
$ 12,514
$ 85,680
2025 F
$ 108,103
$ 150,200
$ 108,459
$ 366,762
$ 110,029
$ 256,733
70%
$ 95,358
$ 187,049
$ 161,375
17%
$ 27,111
$ 134,264
$ 25,673
$ 41,726
$ 14,883
$ 103,328
2026 F
$ 125,399
$ 184,746
$ 124,728
$ 434,873
$ 130,462
$ 304,411
70%
$ 113,067
$ 221,785
$ 191,344
17%
$ 32,146
$ 159,198
$ 30,441
$ 49,475
$ 16,322
$ 123,842
Discount Factor (Pre Tax WACC)
Present Value of Unlevered FCF)
0.95
0.90
0.85
0.81
0.76
$ 53,051 $ 63,071 $ 72,944 $ 83,375 $ 94,709
Discount Factor (Post Tax WACC)
Present Value of Unlevered FCF)
0.95
0.90
0.85
0.81
0.77
$ 53,108 $ 63,207 $ 73,181 $ 83,736 $ 95,222
Interest tax shield
$
57.30
$ 136.32
$ 236.62
$ 360.80
$ 512.59
Figure 14: DCF Model for Microsoft
Sensitivity Analysis (Optimistic Case)
Year
Unlevered FCF
PV of Unlevered FCF
Implied Share price
Less Debt
Add Cash
WACC
Terminal Value
$
$
2
2023
71,897 $
64,722 $
3
2024
89,319 $
76,289 $
4
5
2025
2026
109,572 $ 133,521
88,796 $ 102,664
$ 373.96
78935
130256
5.40%
2.00%
$
Terminal Growth Rate
1
2022
56,286 $
53,404 $
Sensitivity Analysis for Optimistic Case
WACC
373.96
4.38%
4.88%
5.38%
0.50% $ 343.78 $
305.24 $
274.74
1.00% $ 387.61 $
338.43 $
300.63
1.50% $ 446.64 $
381.43 $
333.20
2.00% $ 530.44 $
439.34 $
375.39
2.50% $ 658.73 $
521.55 $
432.21
$
$
$
$
$
5.88%
250.04
270.73
296.14
328.09
369.49
$
$
$
$
$
6.38%
229.65
246.50
266.81
291.74
323.10
Figure 17: Sensitivity Analysis for Microsoft Optimistic Case
14
Sensitivity Analysis (Conservative Case)
Year
Unlevered FCF
PV of Unlevered FCF
Implied Share price
Less Debt
Add Cash
WACC
Terminal Value
$
$
2
2023
68,545 $
61,706 $
3
2024
82,132 $
70,151 $
4
5
2025
2026
97,347 $ 114,725
78,889 $ 88,212
$ 324.97
5.88%
218.49
236.27
258.10
285.56
321.13
6.38%
200.98
215.46
232.90
254.33
281.27
78935
130256
5.40%
2.00%
$
Terminal Growth Rate
1
2022
55,662 $
52,812 $
Sensitivity Analysis for Conservative Case
WACC
324.97
4.38%
4.88%
5.38%
0.50% $ 299.04 $
265.92 $
239.72
1.00% $ 336.70 $
294.44 $
261.97
1.50% $ 387.42 $
331.39 $
289.95
2.00% $ 459.42 $
381.15 $
326.20
2.50% $ 569.65 $
451.79 $
375.02
$
$
$
$
$
$
$
$
$
$
Figure 18: Sensitivity Analysis for Microsoft conservative case
SWOT Analysis
Strength
Firstly, Microsoft is the biggest tech company in the world, maintaining 76.56% of the global operating system
market (Statista). It has a dominant market share - Microsoft ranks 2nd largest Company in the world based on
market value. It also owns the largest market share with a 3% gain among the five largest cloud service
providers (Microsoft, AWS, IBM, Oracle, Google). Secondly, with regards to Branding, Microsoft was ranked
4th by Interbrand as the world’s most valuable brand with the highest brand strength and brand equity in the
digital industry. In the 2020 Forbes Global 2000 Ranking, Microsoft is ranked 13th overall and 6th Top
Regarded Brands in the world. Thirdly, it has a huge consumer base - 1.2 billion Office users and 60 million
Office 365 commercial customers. Trusted brand and loyal customers. Market capitalization of $1.359 Trillion
(Statista) 2nd after Apple. Lastly, it adopts environmentally friendly policies, which increases the reputation
and brand value. It has world-class responsible environmental practices in operations, operating at carbon
neutrality level of 100% since 2012.
Weakness
Firstly, it has a large reliance on the PC markets - Microsoft is largely affected by the forces impacting the PC
market and has no control over its supply chain, with hardware produced by third parties. Over the last few
years, it has also lost market share in the internet browser segment with Internet Explorer and Edge not
performing comparably to Google, Safari and Firefox. Secondly, Cybersecurity is a daily concern to Microsoft’s
operations. MS has experienced several cyberattacks on its software, which may cause consumers to believe
that it may not be as strong as competitors, MS processes 6.5 trillion signals every day to detect breaches in
cybersecurity. Thirdly, MS has made several large unprofitable acquisitions. Microsoft incurred losses through
several of their acquisitions like WebTV, Link Exchange, Massive, Danger, and Nokia for 7.2 billion in 2014.
Opportunities
Firstly, Microsoft could potentially increase R&D efforts to increase the chance of consumers choosing said
innovative technologies over a competitor. Secondly, strategic collaborations and acquisitions can offer
Microsoft gains in diversified sectors and gain market share. Secondly, the Cybersecurity sector is growing and
can be leveraged on by MS. For example, it managed to purchase Cybex for 165 million.
Threats
Firstly, MS faces discrimination issues in the workplace. With the workplace consisting of mostly white men,
this also brings about a significant wage gap between males and females. Workforce demographics have been
found to be 60% white and 75% male. Secondly, Antitrust lawsuits have also alleged that Microsoft has
15
monopolistic tendencies. With MS reportedly placing restrictions on the abilities of manufacturers to install
software other than MS. Thirdly, Cybercrime and Privacy are a significant threat, with source code and software
piracy issues dramatically affecting Microsoft’s security network system. Lastly, Microsoft faces intense
competition from Google, Amazon and Apple who seek to eat up their market share.
16