EVA Analysis Of Microsoft Corporation And Its Segments

Analysis of Microsoft’s Shares and Stocks

Microsoft Corporation has its head offices in Redmond, Washington. It is the leading American multinational company that develops personal computer software systems as well as applications. It also takes part in publishing books. It produces its own tablet computers, offers emailing services and designs electronic game systems. It also manufactures computer peripherals including input and output devices. It has outlets and supply stores in various places all over the world (Microsoft, 2001).

It was founded by Bill Gates and Paul G. Allen, who were two friends since their childhood. They started by converting BASIC, a popular language in computer programing, into a better mode that was suitable for use in the early personal computers commonly known as the Altair (Emery, Finnerty & Stowe, 2007). Later on, the two founded Microsoft Corporation, whose name was derived from the words “microcomputer” and “software”. They afterwards defined BASIC and created various other programming languages (Microsoft Corporation, 2009).

The International Business Machines (IBM) Corporation requested Microsoft Corporation to design an operating system for its first personal computer in the year 1980. Instead, Microsoft bought an operating system from another company and modified it to Microsoft Disk Operating System (MS-DOS). After releasing this software, most companies that manufactured personal computers were able to license MS-DOS as their operating system. This generated a lot of revenue to Microsoft Corporation (Pohlman & Gardiner, 2000).

In the 1990s, Microsoft Corporation became the most powerful and popular company in the history of America. It had become a publicly owned corporation in the year 1986. It was consistently making profits of twenty five percent on each sales dollar. This was really an amazing record. During its 1956 financial year, the company its net income was topped by two billion dollars for the first time, and its profits continued to grow during the great economic recession (Arnold, 2013).

Microsoft’s explosive and rapid growth in its cloud has attracted most investors to venture in its stocks. It competes mainly with Amazon, which is categorized as retail, and does not appear in the technology stock screen. However, Microsoft has the most popularity among investment firms, having been positioned in the second place while Amazon being in the fifth. Microsoft expects to expand and grow its cloud market by forty percent annually. It has tripled its market share to that of Amazon, having grown to three percent unlike Amazon which has only one percent (Microsoft Corporation, 2009).

The performance of Microsoft Corporation in Azure has boosted its annual revenue by twelve percent yearly to twenty four billion dollars. Its net income increased by sixteen percent to six billion dollars. It has used four billion dollars in repurchasing shares and dividends, thus increasing its dividends by eight percent to forty two cents a share. The largest investor guru is the founder of the company, Bill Gates, with outstanding shares of 0.73%. He is followed by Dodge and Cox, with 0.52% of Microsoft’s shareholdings, and then followed by the management of First Eagle Investment with 0.34% shares (Trotta, 2003).

Individual Segments or Elements in Microsoft Corporation

The intelligent cloud segment has realized an income of approximately seven billion dollars, which was reported as a percentage increase of fifteen. The more personal computing segment earned a revenue of twelve billion dollars, up two percent. This gave a total revenue of twenty nine billion dollars, which was a twelve percent annual increase. This raised the gross margin of the company to sixty two percent, and its net operating revenue hit eight billion dollars having increased by ten percent (Atkinson, 2016).

Microsoft Corporation was founded as a technology based company that develops supports and licenses a variety of devices, software and products. The company has three main segments or elements including More Personal Computing, Productivity and Business Processes and Intelligent Cloud. Its main products are operating systems, server applications, server management tools and cross-device productivity applications among others (Microsoft, 2001).

The main devices that it manufactures include the gaming and entertainments tools, personal computers, phones and tablets. In addition, it offers a wide range of services which include cloud-based solutions, consulting services and online advertising that reaches global audience. Each of the above product, service or device falls in one of the segments which are further explained below (Microsoft Corporation, 2009).

1. Intelligent Cloud

The intelligent cloud segment of this company mainly consists of its private and public services as well as hybrid server products including cloud services. It’s primarily comprised of cloud services and server devices (Emery, Finnerty & Stowe, 2007). These comprise of the servers in window, SQL, system center, Azure, related Client Access Licenses (CALs), enterprise services as well as visual studio. The enterprise services include Microsoft consulting and premier support services. The server products are meant to increase the efficiency of the information technology professionals and enhance productivity of their systems (Microsoft, 2001).

The server software integrates infrastructure and middleware and is designed for supporting the operating systems applications in the windows servers. The intelligent cloud is also involved in licensing the standalone and tools for software development lifecycle, which are used by project managers and developers. Azure is an advanced cloud computing platform that has networking, database and storage services. It helps customers and organizations devote resources into developing and using applications, instead of managing the on-premises hardware or software (Microsoft Corporation, 2009).

1. Productivity and Businesses Processes

This is a segment consisting mainly of services and products in the range of the company’s performance, information services and platforms. Its main elements are the office commercial, which includes subscriptions and volume licensing for products and services such as SharePoint, skype, exchange and related Client Access Licenses (CALs). Office commercial helps manage organizational, personal or team productivity via a variety of products and services. Skype is a service that is designed for connecting families, friends and people through devices (Microsoft, 2001).

1. More Personal Computing

This segment of Microsoft Corporation comprises products and services that are aimed at meeting the interests of various end users and developers. It mainly includes windows, mainly covering the windows OEM licensing (Emery, Finnerty & Stowe, 2007). Various devices such as Microsoft surface, personal computer accessories, gaming devices and phones are part of more personal Computing. These devices enable people to connect to other people and acquire content via windows and integrated services of Microsoft. Surface helps consumers, students and organizations to enhance their productivity (Microsoft Corporation, 2009).

Economic Value Added (EVA) Analysis of Microsoft Corporation

According to Rakshit (2012), Economic Value Added (EVA) is an analysis method that compares net operating profit of an investment to its total capital cost or charge. It measures financial performance of a company based on remaining returns after deducting the cost of capital from operating profits after making adjustments for income taxes on the basis of cash. Also termed as the economic profit, this method of analysis reveals the true and fair economic profit of a company (Trotta, 2003).

It gives the additional difference in the rate of return rate over the capital cost of the company. It also gives the value that the business generates from funds that have been invested into it. The analysis helps mainly in measuring the value that is generated by a company from the funds that are shareholders invest into it. It helps in reviewing and seeing the areas of a business that can be highly adjusted to improve the general productivity of the organization (Rakshit, 2012).

The results of Economic value Addition have different indications on decisions that should be made (Schaefer, 2002). For instance, if the Economic Value Added (EVA) of a company is negative, it implies that the company does not generate sufficient value from the funds invested. This implies that the company is value on the funds invested. A business whose Economic value Added remains negative should be shut down. However, if it is positive, it shows that the company is making value out of the funds invested in its business (Atkinson, 2016).

Economic Value Added (EVA) helps investors and management to assess the performance of Microsoft Corporation by considering the wealth and returns created for the shareholders, therefore raising performance above its cost of capital (Schaefer, 2002). Economic Value added (EVA) is a key indicator of financial performance, since it shows how well the company has utilized the assets to generate income. This helps the company management in making viable investment and managerial decisions (Rakshit, 2012).

By reflecting on performance of the company management, Economic Value Added (EVA) indicates how projects of the company are (Issham, 2011). This analysis tool asserts that companies ought to generate returns and profits at a rate higher than the cost of capital. It has many advantages including giving a summary of how much wealth was generated and from which sources. Its inclusion of balance sheet items in calculation ensures that managers consider all assets and expenses in decision making (Atkinson, 2016).

Economic Value Added (EVA) for the Combined Company

Economic Value Added (EVA) is arrived at using the calculation below:

EVA = NOPAT – (Invested Capital * WACC) where NOPAT is the Net Operating Profit after Tax (Rakshit, 2012).

There are three components for arriving at the EVA, that is, Net Operating Profit after Tax (NOPAT), the Weighted Average Cost of Capital (WACC) and the capital invested. These can easily be calculated and can be obtained from the income statement of Microsoft Corporation (Issham, 2011). The invested capital is the amount of cash used in funding a given project. The WACC multiplied by the amount of invested capital arrives at the finance charge, which is the amount needed by investors as a group to make their investment worthwhile (Atkinson, 2016).

Invested capital = Total assets – Current Liabilities

Economic Value Added (EVA) aims at quantifying the cost or charge of making capital investment into a particular project or company, and then assessing if it creates adequate returns for making it a viable investment (Rakshit, 2012).

NOPAT calculation for Microsoft Corporation (in million Dollars):

The year ending Fiscal year 2017 Fiscal year 2016

Net operating income $21,205 $16,797

Deferred income tax expense (benefit) -3,296 332

(Decrease) increase in allowance for doubtful accounts -21 91

Unearned revenue (Decrease) increase 10,570 8,591

Restructuring liability (Decrease) increase -277 -128

Equity equivalents (Decrease) increase 6,976 8,886

Interest expense 2,222 1,243

Lease obligations (Interest expense) 237 170

Interest expense (Adjusted) 2,459 1,413

Interest expense (Tax benefit) -861 -495

After taxes interest expense 1,599 919

Marketable securities loss (Gain) -2,583 -668

Dividends and interest income -1,387 -903

Before taxes, investment income -3,970 -1,571

Investment income from tax expense or income 1,390 550

After taxes, investment income -2,581 -1,021

Operating profit after taxes-Net (NOPAT) 27,198 25,581

Microsoft Corp., invested capital calculation (in million Dollars):

Fiscal year 2017 Fiscal year 2016

Current Debt   $9,072 $12,904

Long-term debt (Current portion) $1,049 –

Long-term debt (less current portion) $76,073 $40,783

Present Value of operating lease payments 6,980 5816

Debt & leases 93,174 59,503

Stockholders’ equity 72,394 71,997

(Assets) liabilities Net deferred tax -1,883 1,256

Provision for doubtful debts 405 426

Unearned income 44,479 33,909

Restructuring liability 432 709

Equity equivalents 43,435 36,301

Accumulated other comprehensive (income) loss -431 -1,537

Adjusted stockholders’ equity 115,398 106,761

Investments -131,341 -117,161

Invested capital 77,231 49,103 

The Weighted Average Cost of Capital (WACC) = 10.99%. Therefore, the Economic Added Value (EVA) for the combined company is calculated as:

EVA = $27,198 – ($77,231 * 10.99%)

= $18,710.31

This is a positive figure, implying that the company is making good returns out of the capital invested in its business (Rakshit, 2012).

Economic Value Added (EVA) for the Segments/Elements Valued Separately

The Net Operating Profit after Tax (NOPAT) from those three major segments was as follows for the financial years 2017 and 2016 (Pohlman & Gardiner, 2000).

2017 2016

Productivity and business processes $11,913 $12,418

Intelligent cloud $9,138 $9,315

More personal computing $8,288 $6,202

Total 22,326 20,182 

EVA for Productivity and business processes = 11,913 – (77,231 * 10.99) = $3,425.31

EVA for Intelligent cloud = 9,138 – (77,231 * 10.99) = $650.31

EVA for more personal computing = 8,288 – (77,231 * 10.99) = ($199.69)

The two segments, intelligent cloud and Productivity and business processes, both have a positive figure for Economic Value Added Analysis. This is an indication that they have a good return on the capital invested in the projects. However, the segment for more personal computing has a negative EVA, meaning that its returns are not as good as the amount of capital invested. The invested capitals’ return rate is lower than the capital cost (Rakshit, 2012).

On analyzing and evaluating Microsoft Corporation using Economic Value Added analysis, it has been found that the business requires huge amounts of capital. Significant proportion of this capital is covered by the cash flows from the more personal computing segment, thus giving it a low EVA (Issham, 2011). The other two segments of the corporation are the Intelligent cloud and Productivity and business processes. These need modest amount of capital and are able to generate amounts of cash flows, thus giving them a high valuation based on the analysis of the Economic Value added (Microsoft Corporation, 2009).

It is therefore very beneficial to separate the company so that the different segments can be valued on their own without being combined. Microsoft Corporation is worth more without the more personal computing segment than when it has it. This would help in analyzing each segment separately as opposed to aggregately. The management will thus be able to take necessary measures to improve the performance of under-performing elements (Rakshit, 2012).

There are other strategic advantages of breaking up a company into individual elements (Schaefer, 2002). For instance, reinventing productivity and business processes would help the company to create new scenarios and opportunities that accelerate digital transformation for businesses. This would be very important in fostering employee culture and engagement by redefining how work gets done in organizations. This would help Microsoft Corporation to reach new potential clients while expanding usage of the company’s services and products by the existing customers (Choi & Click, 2006).

Building the intelligent cloud computing would help transform most organizations digitally. When these businesses transform digitally and move to the intelligent cloud, great opportunities will be created for Microsoft Corporation. The company has made great emphasis on its cloud computing segment and it aims at earning twenty billion dollars annually in commercial clouding (Dess, 2012).

Product development is another strategic advantage used by Microsoft Corporation to increase its sales by making necessary improvements to its present products as well as developing new ones (Issham, 2011). The corporation is missioned to help people and organizations and therefore designing new products is its main concern. Microsoft Corporation has been continually improving its existing products. For instance, Microsoft Office has existed from the year 1992 but it has been improved very year, coming up with more useful features. This is one of the major products of the company that help organizations and people carry out their work (Choi & Click, 2006).

Seeking growth through mergers and acquisitions is another strategic advantage of Microsoft Corporation. The company has acquired several technology companies to become their own (Issham, 2011). These include Yahoo, Nokia Corporation, LinkedIn and Mojang Synergies. This has played a major role in increasing the company’s capabilities, range of its products and value offering. Its acquisition of LinkedIn has particularly played an important role in connecting the professional network to the professional cloud, thus leading to new experiences and exciting value for all users (Rakshit, 2012).

According to Issham (2011), Microsoft Corporation is an organization that is financially stable. It has diversified its technology in computing to provide services to consumer and enterprise markets. It has achieved high gross margins due to its pricing power of its products and services. Its gross margin is approximately sixty percent yearly. Gross profit margin is the net of sales less the cost of sales. The gross profit margin of the company has improved slightly from the fiscal year 2016 to the financial year 2017 (Microsoft Corporation, 2009).

Microsoft Corporation has a debt/equity ratio of only 0.4, indicating that it is free of financial risk. This reduces its need for debt financing, which can be a great burden due to high cost of capital. The Return on Equity (ROE) and Return on Assets (ROA) of the company has improved from 2016 to 2017, indicating that it’s a good organization to invest in (Microsoft, 2001).

According to Emery, Finnerty & Stowe (2007), the stock of Microsoft Corporation increased by four percent. This was after the company reported high revenue for its last quarter in the financial year ended 30^th June 2017. However, the stock went back to its rate after the company announced its financial performance in the following quarter. This was followed by a slight improvement in the premarket trading. The company made twenty five billion dollars income for the whole fiscal year. LinkedIn is believed to have contributed approximately one billion dollars to the productivity of Microsoft Corporation (Dess, 2012).

Conclusion

As discussed above, it can be adequately concluded that Microsoft Company is worth much more if it were broken into individual elements or segments and then valued separately using Economic Value added (EVA) analysis. According to Schaefer (2002), this gives investors an opportunity to value the three different business units of the corporation separately. This would enable them come up with the best investment decisions based on the insights of Economic Value Added (EVA) analysis. The segment for more personal computing would not give Microsoft Corporation a desired Value Added (EVA) analysis (Rakshit, 2012).

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