On Thursday, Morgan Stanley analysts reiterated their Overweight rating on Microsoft (MSFT) with a $245 price target. The analysts see great upside for Microsoft ahead of new Xbox console launches and following the $7.5B acquisition of game developer and publisher Bethesda Softworks.
The long-awaited release of the Xbox Series X/S console is approaching quickly. As expected, Microsoft should experience an uptick in hardware sales driven by the increase of “work/stay/play at home” activities from consumers. “The increase in gaming hardware revenue in FY21 vs.FY20 of $779 million in our model is already pressuring our existing FY21 gross margin estimates by ~35bps”, stated by Morgan Stanley analysts.
The analysts further noted: “Microsoft’s revenue base has grown meaningfully since (MSe $156 billion revenue in FY21 vs $110 billion in FY18), thus making the margin dilutive effect less meaningful now, in our view. Despite this modest gross margin headwind, we look for FY21 gross margins to expand YoY to 69%, ahead of consensus at 68.3%.”
Gross margin fears shouldn’t be as bad as feared with the analysts commenting that “broader gross margin expansion in FY21 remains underappreciated”. FY21 Gross Margins will benefit from accounting changes and continued Azure improvements.
The accounting changes include a ~$2.7 billion benefit to COGS from lower depreciation expenses in FY21. This will tackle Commercial Cloud gross margin, a big concern that investors had come into the fiscal year. This will benefit Azure margins in the coming years, estimated to go from 56.2% in 2020 to 65.0% in 2021. Beyond FY21, analysts expect to see a more measurable pace of expansion supported by growth in Dynamics and Gaming Softwares/Services.
In addition, the argument can be made that the $7.5B Bethesda Softworks acquisition is a justifiable price tag. With the growing Xbox Live community and Game Pass ecosystem, Microsoft’s strategy