Portfolio Manager and Head of ESG
The strength of Jensen’s investment philosophy is based on an unwavering commitment to quality investing. With durable and sustainable competitive advantages, robust growth opportunities, strong financials, and effective leadership, we believe that the inclusion of Microsoft in the Jensen Quality Growth and Global Quality Growth strategies is a demonstration of that commitment.
Microsoft’s deep and sustainable competitive advantages serve as a cornerstone of their success. Of particular note:
- Network Effect – Microsoft’s Windows operating system has over 70% market share according to Statcounter, and Microsoft’s Office Suite has over 50% market share according to Enlyft via Statista. These two legacy products continue to have dominant market share that creates network effects. Each incremental user reinforces these products’ market positions, and a larger population of users benefits from using a common set of tools. This dominant position, in turn, has allowed Microsoft to build a strong, almost “locked-in” revenue stream, which provides the company with the financial base to invest in other growing markets.
- Scale – Software and cloud services are the ultimate scale businesses. Once the software or cloud service is created, it costs very little to produce and sell incremental copies and services. Microsoft has benefited from this since its founding.
- Scope – We deem this as a developing competitive advantage for our cloud-forward companies. Once a relationship is established between the company and customer, the cost of incrementally adding additional services is negligible. This is especially true for Microsoft’s cloud services, where adding incremental services such as artificial intelligence or machine learning is a click away.
- High Switching Costs – Virtually all Microsoft products have some form of switching costs associated with them. The degree varies by product and customer group. Switching costs are generally high for Microsoft’s cloud services and Office Suite due to the network effect and few competitive products offered in the marketplace. For enterprise customers, it’s difficult to remove and switch to another cloud vendor, and customers are often reluctant to change due to the ingrained nature of Microsoft products and cloud services.
Diverse and robust growth opportunities with long runouts
Microsoft is the second-largest cloud vendor, behind Amazon Web Services, and it has steadily gained share. We predict that the shift to cloud and the build-out of cloud services will have a significant runway of opportunity. Statista forecasts the global public cloud market will grow by almost 16% annually in the next five years, and we expect that Microsoft will outpace that estimate while continuing to take share.
Besides expanding cloud services, Microsoft has been focusing its cloud offerings on verticals such as retail and healthcare. Microsoft has positioned itself as the leading cloud vendor in retail, with partnerships with leading retailers such as Walmart, Target, and Kroger, to name a few. Microsoft has also been honing its cloud capabilities to serve the healthcare industry, which leverages its networking and data management capabilities to tie disparate systems together. The company further developed expertise via its recent acquisition of Nuance Communications for its speech recognition and artificial intelligence capabilities aimed at the healthcare industry.
Microsoft also continues to invest in its consumer base. Microsoft is the only enterprise software and cloud company that also serves consumers that the investment team is aware of. It continues to deliver core offerings such as Windows and Office, as well as gaming via PCs, consoles, and streaming. Microsoft’s gaming strategy has been aggressive, with key acquisitions including Mojang (which owns Minecraft) for $2.5 billion, Zenimax (which owns Elder Scrolls and Fallout) for $7.5 billion, and the potential $69 billion acquisition of Activision Blizzard. We’re hopeful that the deal is completed, because the combination would create a strong gaming leader by adding Call of Duty, Overwatch, World of Warcraft, and Candy Crush, to name a few. The deal is expected to close in July 2023, but until then, it is facing significant regulatory scrutiny.
Microsoft’s competitive advantages and growth prospects enabled the company to generate consistent mid-teens annual revenue growth over the last five years, as of August 2022—even through the disruption of COVID-19. Profitability greatly improved, with operating margins up almost 1200 bps over the same period, which drove robust cash flow. Such strong operating performance enabled the company to reinvest in the business, pay down over $30 billion in debt, and return over $180 billion to shareholders in the form of share buybacks and dividends.
Satya Nadella was named CEO in 2016. In our opinion, he has a done a great job at the helm, along with CFO Amy Hood. Over his tenure, he honed the company’s vision, tightened its execution, and better articulated the value Microsoft delivers. We see his message and actions resonating with stakeholders, and our sense is that there is a high degree of optimism across the company. When Nadella was named CEO, we initially saw him as a safe choice. However, he has exceeded our expectations, and in our estimation, he has fulfilled the role as a strong leader and visionary for Microsoft.
We believe Microsoft’s quality attributes continue to grow stronger, and as such it remains one of our core holdings in the Jensen Quality Growth and Jensen Global Quality Growth strategies. This core Jensen holding reflects an ideal of our discipline and deep conviction for investing in quality companies for the long-term.
Please click a link below to view each strategy’s current holdings.
The company discussion in this article is solely intended to illustrate the application of our investment approach and is not to be considered a recommendation by Jensen. The specific security identified is taken from a representative account of each of the Jensen Global Quality Growth Composite and the Jensen Quality Growth Equity Composite and does not represent all of the securities purchased and sold for the Strategies. Our views expressed herein are subject to change and should not be construed as a recommendation or offer to buy or sell any security and are not designed or intended as a basis or determination for making any investment decision for any security. Our discussions should not be construed as an indication that an investment in a security has been or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance of any security discussed herein.
The information contained herein represents management’s current expectation of how the Jensen Global Quality Growth Strategy and the Jensen Quality Growth Strategy will continue to be operated in the near term; however, management’s plans and policies in this respect may change in the future. In particular, (i) policies and approaches to portfolio monitoring, risk management, and asset allocation may change in the future without notice and (ii) economic, market and other conditions could cause the Strategies and accounts invested in the Strategies to deviate from stated investment objectives, guidelines, and conclusions stated herein.
Certain information contained in this material represents or is based upon forward-looking statements, which can be identified by the use of terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “target,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events or results or the actual performance of a client account may differ materially from those reflected or contemplated in such forward-looking statements.
This information is current as of the date of this material and is subject to change at any time, based on market and other conditions. Jensen Investment Management, Inc., is an investment adviser registered under the Investment Advisers Act of 1940. Registration with the SEC does not imply any level of skill or training. Although taken from reliable sources, Jensen cannot guarantee the accuracy of the information received from third parties.