Is Microsoft A Good Metaverse Stock? (NASDAQ:MSFT)

Elevator Pitch

My investment rating for Microsoft Corporation’s (NASDAQ:MSFT) shares is a Hold. My prior March 17, 2022 article for MSFT focused on evaluating the bull and bear case theses for the stock. In this article, I turn my attention to analyzing whether Microsoft is a good proxy for the metaverse investment theme.

MSFT has been investing in both the enterprise and consumer metaverse, which makes it an unique play on the investment theme. Microsoft is doing the right thing by planting the seeds for future growth by making metaverse-related investments. However, it is still uncertain if the metaverse will live up to its potential in the future, and MSFT’s valuations are not particularly enticing. As such, I retain my Hold rating for the company’s shares.

Is MSFT A Metaverse Stock?

MSFT is a metaverse stock. Microsoft might not necessarily be the first name that comes to investors’ minds when the metaverse is mentioned like, say, Meta Platforms (FB) or Roblox (RBLX). But there are many signs that suggest MSFT’s businesses are closely linked to the metaverse.

A new ETF that was recently launched, ProShares Metaverse ETF (VERS), which was established to allow investors to “benefit from the metaverse’s rapid rise” according to a March 17, 2022 Seeking Alpha News article, includes MSFT as one of its top five positions.

Separately, Microsoft mentioned the word “metaverse” three times in the company’s prepared remarks for its Q2 FY 2022 (YE June 30) earnings call, and there was a question asked at the recent quarterly results briefing that focused entirely on MSFT’s growth opportunities associated with the metaverse.

A discussion about MSFT’s metaverse-related products and services today will inevitably revolve around HoloLens and Mesh For Microsoft Teams.

Microsoft has HoloLens when it comes to metaverse-related hardware or devices. The first generation of MSFT’s augmented reality or AR headset, HoloLens 1 was introduced to the market in 2015. Microsoft subsequently introduced the second generation of HoloLens (or HoloLens 2) in 2019. It is important to note that HoloLens 2 sells for a few thousand dollars apiece, and the product is clearly targeting enterprises which differentiates it from cheaper (typically a few hundred dollars) AR headsets sold to consumers. The HoloLens 2 headset already has applications in multiple industries, where companies can save on costs and time using this device, as per the chart below.

HoloLens Is Already Used By Companies In Different Industries

Also, Microsoft announced earlier at its yearly Ignite technology event in November 2021 that it is introducing “Mesh for Microsoft Teams.” At the event, MSFT highlighted that Mesh will allow people to participate virtually in meetings “using personalized avatars and immersive spaces that can be accessed from any device, with no special equipment needed.” In a nutshell, the integration of Mesh with Teams is really all about making mixed-reality meetings possible. First launched in 2017, business collaboration and group chat platform Microsoft Teams has been a big success for the company; it disclosed at its recent Q2 FY 2022 results briefing that “90% of Fortune 500 companies used Teams Phone” in the recent quarter. Demand for “Mesh For Microsoft Teams” will definitely grow with the rise of hybrid work, and it is noteworthy that Mesh is also compatible with HoloLens 2 as highlighted below.

Key Features Of Mesh

I discuss about MSFT’s most significant and recent investment in the metaverse in the subsequent section.

Is Microsoft Investing In The Metaverse?

Microsoft is investing in the metaverse, and the company’s most recent move in that respect was its planned purchase of gaming company, Activision Blizzard announced in a press release dated January 18, 2022. MSFT stressed at its most recent quarterly investor call that this deal will help the company “shape what comes next for gaming as platforms like the metaverse develop.” The transaction is expected to be concluded by the end of FY 2023 (June 30, 2023), assuming that conditions precedent are fulfilled and the relevant regulatory approvals are secured.

As I noted in the preceding section of this article, MSFT has put in significant efforts to make headway in the enterprise metaverse with HoloLens 2 and Mesh For Meetings. The proposed Activision deal puts Microsoft in a good position to gain a strong foothold in the consumer metaverse as well.

A January 10, 2022 Wired article noted that “the things that make the promise of a metaverse intriguing” can already be found in “online games” like World of Warcraft, and highlighted that the metaverse represents “a new way (for gaming companies) to brand their sprawl of digital products and services.” Activision’s flagship game, World Of Warcraft, is often seen to be an “earlier version” and “preview” of the future metaverse, and there are substantial synergies between Activision’s games and Microsoft’s ambitions to expand in the consumer metaverse.

In the next section, I touch on key metrics with respect to Microsoft’s proposed acquisition in Activision which represents a key investment for the company in the consumer metaverse.

MSFT Stock Key Metrics

Microsoft outlined its expectations for the number of gamers worldwide to expand from around 3 billion now to 4.5 billion in the next nine years, as discussed at the company’s M&A investor call on January 18, 2022. MSFT emphasized at its M&A briefing in mid-January that its “vision of the metaverse is based on intersecting global communities rooted in strong franchises.” In other words, Microsoft needs scale in gaming to build a consumer metaverse.

Activision boasted as many as 371 million monthly active users (versus a relatively more modest 25 million Microsoft Xbox Game Pass subscribers) as of the end of 2021, and it is estimated that Microsoft will become the “third largest” company in the gaming space behind only Sony (SONY) (OTCPK:SNEJF) and Tencent (OTCPK:TCEHY) (OTCPK:TCTZF) assuming that the deal is successfully completed.

In summary, the success of Microsoft’s proposed investment in Activision could determine if MSFT is able become a force in the consumer metaverse in the future.

What Is Microsoft’s Long-Term Outlook?

A stock is a good investment, if the company’s long-term growth prospects are not fully reflected in its valuations. In that respect, MSFT is not the best investment candidate.

Microsoft’s revenue and normalized earnings per share are forecasted to grow by five-CAGRs of +15.1% and +19.4%, respectively for the FY 2022-2026 period as per S&P Capital IQ’s consensus estimates. Wall Street analysts also see MSFT’s future ROEs falling in the low-30s to low 40s percentage range for the next five years.

MSFT’s 30.5 times consensus forward next twelve months’ normalized P/E appears to be largely consistent with the company’s expected top line expansion, ROEs and earnings growth going forward. In other words, I don’t see any indicators that MSFT is mispriced.

With regards to the metaverse, it is reasonably safe to assume that the sell-side has not incorporated much of the potential upside relating to the metaverse into the financial forecasts for MSFT or its peers. It is widely accepted by investors and companies that while the metaverse holds a lot of promise in the long term, there is no guarantee that the metaverse investment theme won’t fizzle out just like other technology trends in the past.

As an illustration, Meta Platforms, arguably the company most bullish (considering its corporate name change) on the future of the metaverse, has also expressed its views that it is ready to pivot if things don’t work as planned. FB mentioned at the 2022 Morgan Stanley (MS) Technology, Media and Telecom Conference in March that it “can moderate them over time” assuming it is “less successful.” Specifically, Meta Platforms is saying that if investments in any particular growth area (which could be referring to the metaverse and other investment opportunities) don’t work out well, it is willingly to allocate capital elsewhere.

In conclusion, MSFT’s outlook is good but largely priced in. At the same time, it will be too aggressive to expect significant revenue or earnings accretion from the metaverse theme.

Is MSFT Stock A Buy, Sell, or Hold?

MSFT is a Hold. In my earlier March 17, 2022 update, I rated Microsoft as a Hold “after I weighed the pros and cons of a potential investment in the stock and assessed its valuations using different approaches.” My views have remained unchanged. Microsoft’s investments in the metaverse represent call options, and there could be upside to the company’s financial forecasts and valuations if the metaverse turns out to be a much bigger growth opportunity than what is expected. But as it stands now, Microsoft’s valuations are fair and deserving of a Hold rating.