AmTech’s Donovan Gow makes the bull case for Microsoft (MSFT, Latest Analysis): It’s cheap, and the Xbox division is doing well. He also raises estimates for Microsoft’s Entertainment & Devices Division based on the strong Grand Theft Auto launch (see below).
We think Microsoft’s low P/E (13X forward) is warranted given the uncertainty around the Yahoo acquisition and the company’s ability to transition from a PC-based world to cloud computing. If the Yahoo deal falls apart, the stock should rise modestly, but Gow’s $38 seems a stretch. Gow is right that EDD is performing well, but it is still irrelevant to the company’s bottom-line performance.
Reiterate Buy rating and $38 price target on raised EDD estimates.
While investors remain focused on weak Client performance and MSFT’s OSB outlook, the Entertainment & Devices Division (EDD) continues to perform exceptionally well and is by far MSFT’s fastest-growing division. We are raising our EDD growth estimates on exceptional strength in Xbox 360 driven by the blockbuster GTA IV release, general strength in the gaming sector and resolution of last quarter’s stock-outs. We continue to believe FQ4 and FY09 estimates are very achievable and that any Client weakness will be countered by strength in other divisions, including EDD.
- Gaming has proved to be one of the most resilient sectors in tech with strong results and outlook from ERTS, TTWO and others.
- Grand Theft Auto (GTA) IV, released at the end of April, is by far the strongest release in gaming history, nearly doubling the previous record for first-week sales.
- We believe this will drive incremental EDD growth for MSFT. Furthermore, MSFT has resolved the stock-out issues that hit some retailers last quarter.
- We are raising our FQ4 EDD Y/Y growth estimates from 35% to 47% and our FY09 estimates from 20% to 28%.
- MSFT remains near its all-time forward P/E lows at less than 13x CY09 despite an outlook for 16% top- and bottom-line growth in FY09. We reiterate our $38 price target, which is 16x our CY09 estimate and a P/E/G of 1.1.
Over the last few weeks, our discussions with investors have focused almost exclusively on recent Client weakness, which was down 2% Y/Y in FQ3 and ongoing questions around MSFT’s OSB strategy. While these are legitimate concerns, this glass half-empty mentality ignores areas of strength, most notably the Entertainment and Devices Division (EDD), which is by far MSFT’s fastest-growing business division (+68% in FQ3). Today, EDD is a fairly small division, contributing 11% of revenue last quarter and 3% of operating income since the division swung to profitability three quarters ago. However, we believe these numbers will become increasingly significant over the next few years and that strength in EDD and other areas will offset any softness in Client revenue and still leave ample room for upside to our FY09 estimates, which call for 15% top and bottom-line growth
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