SIMON BROWN: I’m chatting now with Keith McLachlan at Integral Asset Management. Keith, you’ve been buying Microsoft. I tell you what, this is a chart I long used to look at. There was this massive rally in the late nineties. It peaks in, I suppose, early 2000 and then doesn’t get back above those levels until 2017. Talk about a lost decade, with former CEO Steve Ballmer more than anything else, the Justice Department in the US [when Microsoft was accused of monopolising the personal computer market].
But [with CEO] Satya Nadella – this is a new business and a very different Microsoft from what it was back in those heydays in the late nineties.
KEITH McLACHLAN: Morning, Simon. Absolutely. What you really highlighted was the transition of the business from product sales to cloud sales, which is a completely different dynamic. You could see that come through in the cash flows, you can see that come through in the risk profile. You shift once-off sales into annuity contracts, and it’s a much better business, and all the economics are now in its favour.
SIMON BROWN: They are. For one thing, it’s the openness of it. I can remember, I’m on Mac, and you could get Office for Mac but it would be like five years old. And that’s part of what Satya Nadella has done, where he’s basically said, “You know what? We want our software absolutely everywhere”. The bet [is] on cloud – and Azure is out there with, with AWS [Amazon Web Services] as the big player.
KEITH McLACHLAN: Definitely. I’m a great supporter of AWS. I’ll touch on it in in a moment, but cloud is really a scale business when you’re talking about it right there – core cloud. So we’re not talking guys offering things on the cloud, but just core cloud offering. It’s a scale business. Our view is that that market will probably globally consolidate into two, maybe three players.
But if you compare AWS and [Microsoft] Azure versus Google Cloud, Google Cloud is miles behind. They’re just losing. Whether they’ll be able to keep it going we’ll see.
But the problem is you’re not just buying cloud in Amazon. When you buy AWS, you’re buying what last quarter was effectively a loss-making e-commerce business; there’s the second largest employer of labour in in America. That hardly sounds like tech to me, and it’s very much exposed to payroll inflation.
When you’re buying Microsoft, though, you’re getting cloud – which is about a third of revenue and growing at 30% to 40% year on year – winning in terms of that race. But you’re also buying a very, very defensive product business.
So we’re talking about office commercial, office consumer. You’re getting LinkedIn, – which, don’t forget, hidden in the middle, is growing at about 30%, 40% ….
SIMON BROWN: And making real money, surprisingly.
KEITH McLACHLAN: Definitely, definitely. They’ve worked out what their niche is and they’ve absolutely dominated it. Talk to anyone in a recruitment agency and you absolutely need a subscription to LinkedIn. There’s no other way to run that industry now.
And then you’re getting the personal computing side where, remember, they’re making an acquisition of Activision Blizzard to bolt into the Xbox side, and really consolidate that. It’s terrifying, given the scale of Microsoft, to view Activision Blizzard as a bolt-on acquisition. But it really is.
SIMON BROWN: I’ve just looked up – I always forget that they own LinkedIn, [for which the] annual revenue for financial year 2022 was almost $14 billion, up from $8 billion in 2020. As you say, it sort of sits, hiding there.
We’ve talked the cloud part there and that’s defensive. Office of course – corporates the world over are on Office. Can they move to other stuff? Yes. Are they going to? Almost certainly not. [And] the gaming component, Activision [Blizzard], assuming that deal goes through. Of course they’ve got Xbox as well. Is that giant insignificant in their life, or is that really another sort of almost baby LinkedIn?
KEITH McLACHLAN: Well, I would argue it’s not significant in their life. When you look at Microsoft, two-thirds of their revenue comes from highly defensive, inelastic, almost unsubstitutable products. We are talking Office commercial consumer, we’re talking , the cloud. Once you’ve, picked a cloud provider to go with, it’s Azure or AWS, it’s one or the other. I mean, Google Cloud is miles behind and all other cloud providers are a rounding error in terms of market share. You probably largely locked-in. So these are deeply defensive revenues. Gaming’s nice and it’s exciting and it’s interesting. We’ll see what they do with Activision Blizzard once that concludes, but I don’t think it’s significant.
Two-thirds of the revenues, highly defensive, highly inelastic, and they’ve got good pricing power there with few substitutes in.
I suppose Facebook and Google….
Just standing back, one of the big misnomers in in the stock market is calling big tech ‘big tech’. All of these businesses are totally different. And Facebook and Google, their revenue comes from advertising, and that’s cyclical, that’s not defensive. That’s highly competitive.
Two-thirds of Facebook’s revenue is defensive with pricing power. These are totally different characteristics.
SIMON BROWN: That’s a great point. I understand, they’re all big tech, yes, but then they’ve got those nuances. I like that. Inelastic, unsubstitutable – that is perhaps the core of Microsoft. And those are the real deal there.
We’ll leave it there. Keith McLachlan at Integral Asset Management, I appreciate the early morning.
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