From Legacy to Cloud: A Valuation of Microsoft’s Evolving Business Model

☁️💻 Business Overview

Founded in 1975, Microsoft began as a personal computing software pioneer but has since undergone a profound transformation. Once defined by Windows and Office, the company has strategically reinvented itself through bold investments in cloud computing, AI infrastructure, and platform ecosystems like GitHub and LinkedIn.

Today, Microsoft’s core growth engine is Azure, its cloud platform, which—alongside enterprise SaaS products like Office 365 and Dynamics—is driving both scalability and profitability. This shift from legacy software to cloud-first solutions has strengthened its competitive moat and positioned the company as a foundational layer of the modern digital economy.

Underpinned by robust free cash flow, disciplined capital allocation, and a 21-year streak of dividend increases, Microsoft’s evolution reflects not just a shift in products—but in how long-term value is created and sustained.

💵Revenue Exposure & Diversification

The revenues are geographically diversified over the following geographic segments:

• United States: 51.31%
  • 1-Year Revenue Growth = 15.91% (5Y CAGR: 14.59%)
• Other countries: 48.69%
  • 1-Year Revenue Growth = 13.92% (5Y CAGR: 14.45%)

Its also diversified across several business segments:

• Server products and cloud services: 34.94%
  • 1-Year Revenue Growth = 23.31% (5Y CAGR: 18.93%)
  • Estimated Operating Margin: ~45-50%
• Microsoft 365 Commercial products and cloud services: 31.15%
  • 1-Year Revenue Growth = 14.03% (3Y CAGR: 14.50%)
  • Estimated Operating Margin: ~50-55%
• Gaming: 8.33%
  • 1-Year Revenue Growth = 9.08% (5Y CAGR: 15.17%)
  • Estimated Operating Margin: ~30-35%
• LinkedIn: 6.32%
  • 1-Year Revenue Growth = 8.80% (5Y CAGR: 17.14%)
  • Estimated Operating Margin: ~50-55%
• Windows and Devices: 6.15%
  • 1-Year Revenue Growth = 1.69% (5Y CAGR: -9.65%)
  • Estimated Operating Margin: ~30-35%
• Search and news advertising: 4.93%
  • 1-Year Revenue Growth = 12.77% (5Y CAGR: 12.39%)
  • Estimated Operating Margin: ~30-35%
• Dynamics products and cloud services: 2.78%
  • 1-Year Revenue Growth = 14.58% (3Y CAGR: 16.21%)
  • Estimated Operating Margin: ~50-55%
• Enterprise and partner services: 2.75%
  • 1-Year Revenue Growth = 2.19% (5Y CAGR: 3.90%)
  • Estimated Operating Margin: ~45-50%
• Microsoft 365 Consumer products and cloud services: 2.63%
  • 1-Year Revenue Growth = 11.37% (3Y CAGR: 7.42%)
  • Estimated Operating Margin: ~50-55%
• Other: 0.02%
  • 1-Year Revenue Growth = 60% (5Y CAGR: -54.68%)
  • Estimated Operating Margin: ~30-55%

💬Microsoft's Narrative

"Microsoft focus on its business segments with higher margins (cloud and office subscriptions) will drive the overall margins of the business up."

"The company is in a great position to take advantage of the AI boom and be a leader on that front."

🎯Key Insights & Assumptions

• Revenue Growth: 5-Year (CAGR): 14.52% | Last Year: 14.93%
  • Given the historical averages, the recent acceleration of growth and the future prospects, I expect Microsoft revenues to be kept around ~14-15% during the next couple of years.
• Free Cash Flow Growth: 5-Year (CAGR): 9.62% | Last Year: -3.32%
  • I expect this value to be maintained around the ~8-10% given its historical averages and the capital expenditures required for the business to keep growing its AI and Cloud segments.
• Operating Margin: 5-Year Avg: 43.25% | Last Year: 45.62%
  • The margins are improving and are expected to keep the gradual transition to ~50% given the company migration to higher margin segments.
• Return on Invested Capital (ROIC): 5-Year Avg: 30.51% | Last Year: 34.21%
  • Expected to be maintained between ~30-40%.
• Dividend Growth: 10-Year (CAGR): 10.23% | Last Year: 10.67%
  • Forecasted to be around ~10%, in line with the FCF growth.
• Dividend Payout Ratio: 5-Year Avg: 26.27% | Last Year: 24.34%
  • Currently in a very healthy range and expect to continue between ~25-30%.

📈Business Valuation

To assess Microsoft's intrinsic value, we'll use DCF as the valuation method:

• Discounted Cash Flow (DCF) - Intrinsic value is estimated by projecting Microsoft free cash flows over the next 10 years and discounting them to present value.

Microsoft is still a growing company, despite its mature state, giving its cash flows projections more importance for its valuation.

Discounted Cash Flow

📌 Key Assumptions

• Revenue Growth (CAGR) is estimated to be around 15% in Year 1, 14% in Years 2-5 , tapering to 4.23% (risk-free rate) in perpetuity.
• Operating Margin increasing gradually to ~50% , driven by its transition to the higher margins of its cloud business and office solutions.
• Cost Of Capital at ~10.28% considering its global revenue exposure, the median cost of capital for each business segment and Moody's credit rating of Aaa.
• ROIC terminal value will be set to be maintained around ~30% (given its ~30.51% 5-Year Avg), given the maturity of its efficiency systems.

💰 Fair Value Estimate

Based on the DCF model, Microsoft's estimated fair value is $494.83, suggesting that currently the stock may be trading around fair value.