How Microsoft Can Bring in an Extra $3 Billion by Catering Towards Small Businesses

SAN DIEGO, CALIF. (TheStreet) -- Small and medium-sized businesses (SMBs) represent Microsoft's (MSFT) next multi-billion dollar opportunity, according to analyst firm Pacific Crest, which said Monday that more companies in the sector are upgrading from Microsoft Office licenses to costlier cloud-based subscription offerings such as Office 365 and Azure.

"Based on our estimates, it is likely that Microsoft could generate as much as an additional $3 billion in recurring incremental net profit by moving its commercial office installed based to Office 365," Pacific Crest Analyst Brendan Barnicle wrote in the firm's latest note.

In the September quarter, sales from Microsoft's "Commercial Other" segment, which includes revenue from SMB Office 365 and Azure licenses, totaled $2.4 billion in revenue, good enough for 150% year-over-year growth. In total, Microsoft earned an adjusted 54 cents a share on $23.20 billion in revenue in its fiscal year 2015 first quarter, besting Thomson Reuters estimates of 50 cents a share on $22 billion in revenue.

After recent reseller checks, Pacific Crest increased its December quarter estimate for commercial other revenue by $100 million to $2.7 billion. As a result, the firm has also upped its overall earnings per share estimate for the quarter to 75 cents, 3 cents greater than the market consensus. Pacific Crest holds an "outperform" rating and a 12-month price target of $54 for the software giant.

"In recent reseller checks domestically and internationally, we have heard of a strong acceleration in SMB demand for Office 365 and Azure," Barnicle said. "The move to Office 365 is very good for Microsoft's financials. Microsoft estimates that each commercial office license that moves to Office 365 generates an incremental 50% increase in the company's gross profit."

Pacific Crest's calculation for $3 billion more in incremental net profit is more a hypothetical scenario than a realistic estimate as it assumes a number of factors, including a 100% upgrade rate from commercial office to Office 365. The firm estimates that Microsoft made as much as $11.25 billion in gross profit from SMB commercial office licenses in 2013. With the 50% multiplier tacked on for upgrades to Office 365, then the additional annual gross profit, if all SMBs switched, would be $5.625 billion. After calculating for a 50% operating margin on Office 365, the operating profit boils down to $3.75 billion, which comes out to $3 billion after taxes.

Shares of Microsoft were down in Monday trading, falling 0.44% to $47.77. However, the newly self-labeled "productivity and platform" company has gained close to 8% in value since its first quarter report on Oct. 23.

--Written by Jennifer Van Grove in San Diego, Calif.

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