Microsoft (MSFT) F4Q17 Preview: New CS Survey Suggests Inflection Point for Azure; Increase Target

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1 Americas/United States Equity Research Software Rating OUTPERFORM Price (13-Jul-17, US$) Target price (US$) (from 80.00) week price range (US$) Market cap (US$ m) 554, Target price is for 12 months. Research Analysts Michael Nemeroff Alexander Hu Christopher Rochester Share price performance Sep N o v Ja n M ar M ay Ju l M SFT.O Q S& P IN D EX On 13-Jul-2017 the S&P 500 INDEX closed at Daily Jul14, Jul13, 2017, 07/14/16 = US$53.74 Quarterly EPS Q1 Q2 Q3 Q4 2016A E E Microsoft (MSFT) INCREASE TARGET PRICE F4Q17 Preview: New CS Survey Suggests Inflection Point for Azure; Increase Target Microsoft is scheduled to report F4Q17 results on Thursday, July 20 with a call that day at 5:30PM ET. Dial in: New CS Survey Indicates Azure Momentum Could Accelerate: Our recent enterprise software survey suggests that demand for Azure could be at a positive inflection point. Specifically, we note that MSFT saw the largest improvement among all cloud vendors, as 40% of respondents indicated that Azure was their preferred cloud vendor (up nearly double from 21% six months ago). This combined with very recent positive commentary re: Azure from several third-party vendors gives us conviction that MSFT could exceed our F4Q17/FY18 Azure revenue ests of $1.3B (+90% yr/yr)/$6.6b (+79%). Office 365 and Windows 10 Penetration Continues Unabated: 38% and 27% of enterprise respondents have already adopted Office 365 and Windows 10, respectively, which is a large uptick from January. Further, we highlight that 36% still plan to upgrade to O365 within 24 months, while 10% noted that upgrading was a priority but haven't set a date yet, which give us increased confidence in our O365 MAUs forecast of ~160M in FY19. We expect F4Q: Total revenue of $24,296M (+7.3% yr/yr) vs. Street of $24,265M; Productivity and Business Processes of $8,349M (+19.8%), which includes $1,050M revenue contribution from LinkedIn; Intelligent Cloud of $7,362M (+9.7%); More Personal Computing of $8,586M (-3.5%), largely due to mgmt's expectations for a decline in Surface (CS ests -15% yr/yr). We model GM% of 66.0% vs. implied guide of %, which could be lower if hardware outperforms; EPS of $0.70 vs. Street of $0.71. Top Pick: Our Outperform thesis on MSFT shares is centered on what we view as significant earnings power potential over the next few years, which could be unlocked from (1) strong commercial cloud growth and (2) higher cloud gross margins due to economies of scale, ultimately driving our aboveconsensus EPS ests. See our report The Microsoft Cloud Forms and Grows. Valuation: Our new $84 target price (from $80) implies a C2018 P/E multiple of 23.5x (21.5x excl. SBC). Risks to our ests include competition and macro. Financial and valuation metrics Year 6/16A 6/17E 6/18E 6/19E EPS (Excl. ESO) (US$) EPS (CS adj., ) Prev. EPS (CS adj., US$) P/E (CS adj.) (x) P/E rel. (CS adj., %) Revenue (US$ m) 91, , , ,516.0 EBITDA (US$ m) 34, , , ,801.9 Net Debt (US$ m) 47,177 78,459 72,446 64,362 OCFPS (US$) P/OCF (x) Number of shares (m) 7, Price/Sales (x) 5.82 BV/share (Next Qtr., US$) 9.0 P/BVPS (x) 8.0 Net debt (Next Qtr., US$ m) 78,458.9 Dividend (current, US$) - Dividend yield (%) - Source: Company data, Thomson Reuters, Credit Suisse estimates DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, LEGAL ENTITY DISCLOSURE AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

2 Microsoft (MSFT) Price (13 Jul 2017): US$71.77; Rating: OUTPERFORM; Target Price: (from US$80.00) US$84.00; Analyst: Michael Nemeroff Income Statement 6/16A 6/17E 6/18E 6/19E Revenue (US$ m) 91, , , ,516.0 Sales 91, , , ,516.0 EBITDA 34, , , ,801.9 Operating profit 27, , , ,152.8 Recurring profit 27, , , ,552.8 Cash Flow 6/16A 6/17E 6/18E 6/19E Cash flow from operations 33,305 37,265 42,443 47,518 CAPEX (8,343) (9,196) (10,100) (10,810) Free cashflow to the firm 24,962 28,069 32,343 36,708 Cash flow from investments (23,950) (42,762) (10,100) (10,810) Net share issue(/repurchase) (15,301) (13,048) (13,528) (15,123) Dividends paid (11,006) (11,837) (12,802) (13,500) Issuance (retirement) of debt 18,283 29, Other (18,744) (30,496) (0) (0) Cashflow from financing activities (26,768) (25,789) (26,330) (28,623) Effect of exchange rates (67) Changes in Net Cash/Debt (17,480) (31,282) 6,013 8,084 Net debt at end 47,177 78,459 72,446 64,362 Balance Sheet ($US) 6/16A 6/17E 6/18E 6/19E Assets Other current assets 112, , , ,126 Total current assets 139, , , ,804 Total assets 193, , , ,420 Liabilities Short-term debt 12,904 7,786 7,786 7,786 Total current liabilities 59,357 58,934 63,142 67,160 Long-term debt 40,783 76,222 76,222 76,222 Total liabilities 121, , , ,387 Shareholder equity 71,997 69,880 74,242 80,033 Total liabilities and equity 193, , , ,420 Net debt 47,177 78,459 72,446 64,362 Per share 6/16A 6/17E 6/18E 6/19E No. of shares (wtd avg) 8,002 7,829 7,754 7,686 CS adj. EPS Prev. EPS (US$) Dividend (US$) Free cash flow per share Earnings 6/16A 6/17E 6/18E 6/19E Sales growth (%) (1.7) EBIT growth (%) (0.8) Net profit growth (%) EPS growth (%) EBIT margin (%) Valuation 6/16A 6/17E 6/18E 6/19E EV/Sales (x) EV/EBIT (x) P/E (x) Quarterly EPS 2016A Q Q Q Q E E Company Background Microsoft provides cloud computing services, desktop and server management tools, productivity software applications, enterprise services, consumer electronics, operating systems, and personal computers to businesses and consumers. Blue/Grey Sky Scenario Our Blue Sky Scenario (US$) (from 90.00) Better than expected traction in Commercial Cloud, further monetization of its large piracy base, increased penetration in emerging markets, and continued operational efficiencies driven by significant economies of scale result in revenue CAGR of +6.6% from F2020 to F2026 and terminal operating margin of 44.7%. This yields a blue sky scenario of $96 per share, which implies a C2018 P/E multiple of 26.9x (or 24.6x excl. SBC). Our Grey Sky Scenario (US$) (from 50.00) Increased competition, heavier than anticipated pricing discounts, failure to successfully integrated large M&A transactions, and unexpected delays in software upgrades / new product offerings result in revenue CAGR of only +4.8% from F2020 to F2026 and terminal operating margin of 20.2%. This yields a gray sky scenario of $56 per share, which implies a C2018 P/E multiple of 15.7x (or 14.3x excl. SBC) Share price performance Se p N o v Ja n M ar M ay Ju l M SFT.O Q S& P IN D EX On 13-Jul-2017 the S&P 500 INDEX closed at Daily Jul14, Jul13, 2017, 07/14/16 = US$53.74 Source: Company data, Thomson Reuters, Credit Suisse estimates Microsoft (MSFT) 2

3 I. New CS Enterprise Software Survey We recently conducted an update to our late 2016 / early 2017 software survey of enterprise executives (CIOs, CTOs, IT Directors; see page 12 for survey demographics), which suggests an inflection point for Microsoft Azure compared to early 2017 (this update surveyed ~70% of the same respondents). Specifically, we note that MSFT saw the largest improvement among all cloud vendors (Google Cloud showed second largest improvement), as 40% of respondents indicated that Azure was their preferred cloud vendor (up nearly double from 21% six months ago). We continue to expect Azure to gain market share in the IaaS/PaaS markets due to its competitive differentiators (i.e., hybridcloud platform, enterprise-grade capabilities, and hyperscale infrastructure) and market/product positioning (i.e., open ecosystem, interoperability, and enterprise edge). MSFT saw the largest improvement among all cloud vendors; 40% of survey respondents indicated that Azure was their preferred cloud vendor, nearly doubled vs. early Figure 1: *NEW Data Who is your cloud vendor of choice? Microsoft Azure 21% 40% Amazon AWS 32% IBM SoftLayer/Bluemix 7% 10% 49% Google Cloud 3% 8% Other 10% 20% 0% 10% 20% 30% 40% 50% 60% 2017 Outlook Mid-Year Update Source: Credit Suisse estimates, GLG. With regards to the Windows 10 upgrade cycle, 27% of respondents are now on the new operating system (up from only 15% six months ago) as MSFT continues to make steady progress on Windows 10 penetration at large enterprises. 48% of enterprise respondents plan to upgrade their organization to Windows 10 within the next 24 months, while 15% noted that upgrading to Windows 10 was a priority but haven't set a date yet. Figure 2: *NEW Data When do you plan to upgrade your company to Windows 10? <12 months 30% 36% Already have 15% 27% >12 months, but within 24 months 18% 30% To be determined, but on the priority to-do list No plans yet - Not a priority in the near-term 11% 15% 8% 10% 0% 10% 20% 30% 40% 2017 Outlook Mid-Year Update Source: Credit Suisse estimates, GLG. Microsoft (MSFT) 3

4 Regarding Microsoft Office 365 penetration, 38% of enterprise respondents have already migrated to Office 365, 36% plan to upgrade within the next 24 months, while 10% noted that upgrading was a priority but haven't set a date yet. These survey results give us increased confidence in our Office 365 Commercial Monthly Active Users (MAUs) forecast of ~160M in FY19, which we recently raised post-analyst Day (see Analyst Day Takeaways; More Cloud Growth, but Expense Guide Predictably Foggy). While our proprietary bottom-up model suggests that Office 365 Commercial has been one of the leading drivers of gross profit dollar growth over the past few years, we expect that momentum to continue due to (1) increased penetration, and (2) further monetization / upsell opportunity through higher-tier subscription plans. Figure 3: *NEW Question When do you plan to upgrade your company to Office 365? Already have 38% <12 months 23% No plans yet - Not a priority in the near-term 15% >12 months, but within 24 months 13% Haven't determined when yet, but it's on the priority to-do list 10% 0% 10% 20% 30% 40% 50% Mid-Year Update Source: Credit Suisse estimates, GLG. "In the quarter, we won new cloud business with a Fortune 10 customer through our partnership with Azure." "Microsoft is appealing to a mainstream corporate buyer that's really now just leaning into that public cloud opportunity." Recent Public Comments from Third-Parties on Azure Related to New Business in Microsoft s F4Q17 Barracuda Networks (CUDA) CEO William Jenkins (July 10, 2017): "In the (most recent) quarter, we won new cloud business with a Fortune 10 customer through our partnership with Azure." Red Hat (RHT) CEO James Whitehurst (June 20, 2017): "The Microsoft Cloud (Azure) is growing very, very, very fast, obviously off of a lower base but we're seeing really nice growth in both of those (AWS, Azure)". General Electric (GE) Chief Digital Officer William Ruh (June 14, 2017): "We don't ride on one infrastructure, one cloud. We run on AWS today. We've announced we'll (also) be on Azure." Talend SA (TLND) CEO Michael Tuchen (June 14, 2017): "We're seeing a big shift right now in the cloud market, as we're moving to a more mainstream buyer profile, and we're seeing some of the use cases evolve. If you were to talk to me two years ago about what we're seeing in the cloud, we would have said 90% Amazon and everyone else is fighting for the 10%. These days, we're seeing 60% Amazon; Microsoft, probably about 30%; and Google 10%. Microsoft is appealing to a mainstream corporate buyer that's really now just leaning into that public cloud opportunity. They have strong Microsoft premise relationships. They have a development team that's using SQL server, that's using a Visual Studio Microsoft (MSFT) 4

5 and.net, plenty of Windows Servers sitting around in that thing. And in that world, Azure is a pretty natural choice for them in particular, because Microsoft created something called the Hybrid Use Benefit." Citrix Systems (CTXS) CEO David Henshall (June 13, 2017): "The last 12 months, we've seen a really renewed interest in the other cloud and then particularly with Microsoft Azure, we see them coming on very strong." "And after a pretty extensive and detailed assessment, Microsoft was the clear standout." "We'll host that (workloads) primarily out of Azure. It's a natural partnership when people think about applications in Microsoft and what not, so I think that's our strategic cloud for hosting our infrastructure. We obviously participate a lot with Amazon and Google, and others, and so it's not a one cloud strategy, just can't be." New Relic (NEWR) Chief Product Officer / CTO James Gochee (June 8, 2017): "Nobody wants to behold into a single vendor. And Amazon, they blazed the trail on cloud, by far and away in our customer base number one cloud provider that we see people use. But we have in particularly the last 12 months, we've seen a really renewed interest in the other cloud and then particularly with Microsoft Azure, we see them coming on very strong." Infosys (INFY) CEO Vishal Sikka (May 31, 2017): "We have a huge partnership with Microsoft in Azure. In this area, one of our large clients just announced a big plan to move to Azure in the retail area. And so, it is driven by getting the efficiency of the cloud, getting the cost efficiency, getting elasticity in performance and things of this nature." Qualys (QLYS) Chief Information Security Officer Mark Butler (May 23, 2017): "I would say, the dramatic growth is going to be either workloads moving from private clouds to public and/or more workloads moving from hybrid clouds into public. So most of the consumption we see right now is in AWS, just based on the longevity of how long AWS has been around. But Azure is closing in fast and Google Cloud is obviously progressing as well." CDW Corp (CDW) Investor and Analyst Day (May 11, 2017): "We lead with Microsoft Azure for now because of the strength of story around hybrid delivery." Avid Technology (AVID) Chairman, CEO Louis Hernandez, Jr. (May 10, 2017): "We went through a six-month process to evaluate all major cloud vendors through a set of criteria in RFP that included the scale of the cloud network, the enterprise experience of the vendor. We looked at the flexibility of the approach to cloud deployments, we evaluated the strategic alignment and cultural fit, we looked at their investment in media and entertainment as an area of focus. And after a pretty extensive and detailed assessment, Microsoft was the clear standout." Microsoft (MSFT) 5

6 II. Commercial Cloud Still in Early Stages of its Life Cycle As we highlighted in our initiation report (see The Microsoft Cloud Forms and Grows), a large part of our Outperform thesis on MSFT is centered on what we view as significant earnings power potential over the next few years, which could be unlocked from (1) strong commercial cloud growth (Azure, Office 365) and (2) higher cloud gross margins due to economies of scale. This increased mix shift of cloud revenue (while % margin dilutive in the near-term) should lead to accelerating gross profit dollar growth, which largely drives our above-consensus EPS estimates. Figure 4: MSFT Key Operating Metrics Reference Sheet (CS estimates) Microsoft Key Metrics Summary (CS ests) F2014A F2015A F2016A F2017E F2018E F2019E Amounts in US$millions, except per share data Jun '14 Jun '15 Jun '16 Jun '17 Jun '18 Jun '19 Commercial Cloud Revenue 2,807 5,770 9,452 14,816 21,560 29,694 % Change Yr/Yr 116.0% 105.6% 63.8% 56.8% 45.5% 37.7% % of Total Revenue 3.2% 6.2% 10.3% 15.4% 20.7% 26.6% Azure ,876 3,677 6,562 10,761 % Change Yr/Yr % 112.6% 96.0% 78.5% 64.0% % of Commercial Cloud Revenue 13.9% 15.3% 19.8% 24.8% 30.4% 36.2% Office 365 Commercial 2,221 4,668 7,236 10,539 14,072 17,546 % Change Yr/Yr % 55.0% 45.6% 33.5% 24.7% % of Commercial Cloud Revenue 79.1% 80.9% 76.6% 71.1% 65.3% 59.1% Dynamics ,387 % Change Yr/Yr % 54.5% 76.7% 54.2% 49.6% % of Commercial Cloud Revenue 7.0% 3.8% 3.6% 4.1% 4.3% 4.7% Commercial Cloud Gross Profit 413 2,516 4,222 7,427 11,991 17,837 Commercial Cloud Gross Margin % 14.7% 43.6% 44.7% 50.1% 55.6% 60.1% % Change Yr/Yr % 67.8% 75.9% 61.5% 48.8% Azure Gross Profit (934) (394) (33) 153 1,928 5,087 Azure Gross Margin % (239.4)% (44.6)% (1.8)% 4.2% 29.4% 47.3% Office 365 / Dynamics 365 Gross Profit 1,347 2,909 4,256 7,274 10,063 12,750 Office 365 / Dynamics 365 Gross Margin % 55.7% 59.5% 56.2% 65.3% 67.1% 67.3% Office 365 Commercial Monthly Active Users (MAUs) 29.8m 51.8m 75.1m 105.6m 134.8m 160.0m Office 365 Commercial Monthly ASP ($) $ 8.27 $ 9.54 $ 9.50 $ 9.72 $ 9.76 $ 9.92 Office 365 Home Subscribers 5.6m 15.2m 23.1m 26.9m 30.1m 32.9m Office 365 Home Monthly ASP ($) $ 5.70 $ 5.45 $ 5.79 $ 5.83 $ 5.83 Azure revenue grow th (yr/yr) % 112.6% 96.0% 78.5% 64.0% Server products revenue grow th (yr/yr) 11.4% 7.0% (1.1)% 3.6% (0.5)% (5.0)% Window s 20,424 17,329 16,458 16,722 16,580 16,476 % Change Yr/Yr (15.2)% (5.0)% 1.6% (0.9)% (0.6)% % of Total Revenue 23.5% 18.5% 17.9% 17.4% 15.9% 14.8% Window s OEM Pro revenue grow th (yr/yr) 12.0% (15.0)% (6.0)% 4.2% 1.0% 1.0% Window s OEM non-pro revenue grow th (yr/yr) (17.0)% (16.0)% 7.0% 0.0% (1.4)% (1.5)% Microsoft (MSFT) 6

7 Figure 5: Expect Commercial Cloud Growth Figure 6: and Gross Margin Expansion Revenue ($B) $35.0 $30.0 $25.0 $20.0 $15.0 $10.0 $5.0 $0.0 $14.8B +57% $21.6B +46% $6.6 $29.7B +38% $10.8 $9.5B $5.8B +64% $ % $17.5 $1.9 $14.1 $0.9 $10.5 $0.4 $7.2 $2.2 $4.7 $0.2 $0.2 $0.3 $0.6 $0.9 $1.4 FY14 FY15 FY16 FY17E FY18E FY19E Commercial Cloud Gross Profit ($B) $20.0 $16.0 $12.0 $8.0 $4.0 $0.0 50% 60% 56% $ % 45% $ % $7.4 $4.2 $0.4 $2.5 FY14 FY15 FY16 FY17E FY18E FY19E 70% 60% 50% 40% 30% 20% 10% 0% Commercial Cloud Gross Margin (%) Dynamics 365 Office 365 Commercial Azure CC Gross Profit ($B) CC Gross Margin (%) Our Proprietary Bottom-Up Revenue Build Drives Our Commercial Cloud Thesis We constructed an explicit product-by-product, bottom-up historical analysis and forecast for MSFT based on publicly available information (segment results disclosures, SEC filings, presentations, transcripts, analyst day). Our proprietary deep-dive revenue/cost build suggests that the company s Commercial Cloud business remains in the early innings of its growth and leverage cycle, particularly Azure. In addition, we expect sustained gross profit dollar growth from Office 365 Commercial given the survey results highlighted earlier in this note, as well as potential revenue upside in Dynamics 365 based on new data we recently collected in our mid-year software survey that implied better than expected investment in sales-focused software (see Mid-Year Software Survey Update; SaaS Unit Economics Index; Top Picks). Figure 7: Our Proprietary, Explicit, Product Bottom-Up Revenue Build $120.0 Revenue ($B) $100.0 $80.0 $60.0 $40.0 $20.0 $0.0 FY14 FY15 FY16 FY17E FY18E FY19E Productivity & Business Processes Intelligent Cloud More Personal Computing Office Consumer Office Commercial Dynamics Office Consumer Svcs & Other LinkedIn Server Products & Cloud Svcs Enterprise Services Windows Devices Gaming Search Microsoft (MSFT) 7

8 enterprises look to spend as much as 23% of all IT investment dollars on cloud over the next three years Given the decades long shifts in software we ve seen in the past (mainframe, distributed, and now cloud) we believe the enterprise move to the cloud could last for several years, if not decades, as only a fraction of enterprise computing workloads are there currently (Oracle has publicly commented that they believe only 5-6% of all current enterprise workloads are being run in the cloud). Further, our recent mid-year software survey (see Software Mid-Year Update: New Software Survey Takeaways) suggests that cloud momentum, both public and private, will remain strong as enterprises look to spend as much as 23% of all IT investment dollars on cloud over the next three years, citing the associated expense reductions and increased agility in new application deployment as the biggest drivers. Given MSFT s (1) large installed base of enterprise customers, (2) significant, existing relationships with enterprises of all sizes, (3) strong product differentiators (hybrid cloud strategy with enterprise-grade capabilities and a hyperscale infrastructure), (4) an already large but rapidly expanding ecosystem of partners and thirdparty vendors, and (5) continued innovation/increased operational efficiencies on both hardware and software, we believe Azure will continue to see strong sustained growth while generating incremental leverage. Figure 8: Azure Revenue Growth and Gross Margin Expansion Azure Revenue ($B) $12.0 $9.0 $6.0 $3.0 $0.0 47% 29% (2)% 4% $10.8 (45)% +79% CAGR $6.6 $3.7 (239)% $1.9 $0.4 $0.9 FY14 FY15 FY16 FY17E FY18E FY19E Azure Revenue ($B) Azure Gross Margin (%) 100% 50% 0% (50)% (100)% (150)% (200)% (250)% (300)% Azure Gross Margin (%) Our proprietary bottom-up revenue model also suggests that Office 365 Commercial has been one of the leading drivers of gross profit dollar growth over the past few years; our recent survey results give us increased confidence that the momentum will continue due to: (1) increased penetration (CS ests Office 365 remains under-penetrated among total office users at 10%), and (2) further monetization / upsell opportunity through higher-tier subscription plans. Microsoft (MSFT) 8

9 Figure 9: Credit Suisse Office 365 Commercial Revenue Growth and Gross Margin Forecasts Figure 10: Office 365 Commercial Gross Profit $ versus Commercial Cloud Office 365 Commercial Revenue ($B) $20.0 $18.0 $ % 66.4% 67.6% 64.5% 59.5% 58.9% 56.7% $ % $14.0 $ % $12.0 $10.0 $ % $8.0 $6.0 $7.2 25% $4.0 $4.7 13% $2.0 $2.2 $0.0 0% FY14 FY15 FY16 FY17E FY18E FY19E Office 365 Commercial Revenue Office 365 Commercial Gross Margin % Office 365 Commercial Gross Margin (%) Gross Profit Dollars ($B) $20.0 $16.0 $12.0 $8.0 $4.0 $0.0 Office 365 Commercial has been a leading driver of gross profit dollar growth, and we expect that to continue for the next few years (though it will be less as a % of total Commercial Cloud) $1.3 $2.8 $2.5 $0.4 $4.3 $4.2 $7.4 $6.8 92% $9.3 78% $12.0 $ % $17.8 FY14 FY15 FY16 FY17E FY18E FY19E Office 365 Commercial Gross Profit $ Total Commercial Cloud Gross Profit $ Figure 11: Credit Suisse Office 365 Subscriber Build (Commercial + Consumer) Figure 12: Office 365 Commercial Bottom-Up # of Total Office 365 Users (in millions) Sep '13 Dec '13 Mar '14 Jun '14 Sep '14 Dec '14 CS ests ~126M Office 365 users in F3Q17 Mar '15 Jun '15 Sep '15 Dec '15 Mar '16 Jun '16 Sep '16 Dec '16 Mar '17 Jun '17E Sep '17E Dec '17E Mar '18E Office 365 Commercial Monthly Active Users (MAUs) Office 365 Consumer Subscribers Jun '18E Sep '18E Dec '18E Mar '19E Jun '19E Office 365 Commercial MAUs (in millions) $9.54 $9.50 $ $9.76 $ FY15 FY16 FY17E FY18E FY19E Office 365 Commercial MAUs Office 365 Commercial Monthly ARPU $11 $10 $9 $8 $7 $6 $5 Office 365 Commercial Monthly ARPU ($) Microsoft (MSFT) 9

10 III. Valuation Our new $84 target price is based on a blended average, using 50% of our discounted cash flow (DCF) valuation (10.9% WACC, 3.0% terminal growth) and 50% of our weighted relative multiple. Our new target price implies a P/E multiple of 23.5x on our C2018 estimate (or 21.5x excluding SBC), a warranted premium to that of the group average given our expectations for sustained growth in Commercial Cloud while generating incremental leverage. In addition, we believe that as more of MSFT s revenue stems from recurring sources (e.g., subscription/transactional revenue), this could lead to further multiple expansion (see Figures 13 to 15). Figure 13: MSFT Price/Earnings (NTM) Valuation Index versus % Cloud Revenue 24.0x 25% 22.0x 20% 20.0x +1 Sigma 18.0x 16.0x 14.0x Avg = 17.3x -1 Sigma 15% 10% 12.0x 5% 10.0x 0% Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 P/E Multiple % Cloud Revenue Source: Thomson Reuters, Credit Suisse estimates. Microsoft (MSFT) 10

11 Figure 14: MSFT EV/Sales (NTM) Valuation Index versus % Cloud Revenue 5.5x 25% 5.0x 20% 4.5x 4.0x +1 Sigma 15% 3.5x Avg = 3.6x 10% 3.0x 2.5x -1 Sigma 5% 2.0x 0% Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 EV / NTM Sales % Cloud Revenue Source: Thomson Reuters, Credit Suisse estimates. Figure 15: MSFT EV/Operating Cash Flow (NTM) Valuation Index versus % Cloud Revenue 14.0x 25% 13.0x 12.0x 11.0x +1 Sigma 20% 15% 10.0x Avg = 10.2x 9.0x -1 Sigma 10% 8.0x 5% 7.0x 6.0x 0% Dec-13 Mar-14 Jun-14 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-17 Jun-17 EV / NTM OCF % Cloud Revenue Source: Thomson Reuters, Credit Suisse estimates. Microsoft (MSFT) 11

12 CS Software Survey of Executives at Large Enterprises The Credit Suisse software survey focuses on larger enterprises (>2,500 employees with varied revenue distribution of at least $2B with the majority stemming from organizations with >50,000 employees and >$14B revenue) across all geographies and verticals. This update surveyed ~70% of the same respondents we polled in early Figure 16: CS Software Survey Focuses on Larger Enterprises Figure 17: With Varied Revenue Distribution Above $2 Billion >50K Employees 30% 40K-50K 8% 30K-40K 8% <5K 12% 20K-30K 18% 5K-10K 12% 10K-20K 12% >$14B Revenue 37% $10B to $14B 17% $2B to $4B 12% $4B to $6B 18% $6B to $10B 17% Source: Credit Suisse estimates, GLG. Source: Credit Suisse estimates, GLG. Figure 18: From Around the World Figure 19: and Across All Verticals Government Transportation Natural Resources Utilities EMEA 12% APAC 15% Manufacturing Insurance Other Banking and Securities North America 73% Education Media Healthcare Automotive IT Services Retail Source: Credit Suisse estimates, GLG. Source: Credit Suisse estimates, GLG. Microsoft (MSFT) 12

13 Guidance and Estimates Figure 20: Quarterly Ests vs. Consensus (F4Q17) USD in millions, unless otherwise stated Quarterly Estimates and Guidance Variance Analysis Guidance Consensus Credit Suisse Jun '17E Jun '17E Jun '17E Productivity and Business Processes 8,200-8,400-8,349 Intelligent Cloud 7,200-7,400-7,362 More Personal Computing 8,400-8,700-8,586 Total Revenue $23,800-24,500 $ 24,263 $ 24,296 Total Cost of Revenue 8,200-8,300 8,439 8,254 Gross Profit 15,823 16,043 Gross Margin % % 65.2% 66.0% Total Operating Expenses 9,100-9,200 8,978 9,135 Operating Income 6,845 6,907 Operating Margin % % 28.2% 28.4% Total Other (expense) income, net Pro forma pretax income 6,985 7,057 Effective tax rate 21.4% 22.5% Pro forma Net Income 5,491 5,469 Pro Forma EPS Fully Diluted $0.71 $0.70 Shares Outstanding (fully diluted) 7,779 7,796 Total Unearned Revenue - 41,250 Cash Flow from Operations 9,088 8,763 Capital Expenditures 2,794 3,350 Free cash flow 6,294 5,413 Source: Thomson Reuters, Company data, Credit Suisse estimates. Figure 21: Quarterly Ests vs. Consensus (F1Q18) USD in millions, unless otherwise stated Quarterly Estimates and Guidance Variance Analysis Consensus Credit Suisse Amounts in US$millions, except per Sep '17E Sep '17E Productivity and Business Processes - 8,256 Intelligent Cloud - 6,924 More Personal Computing - 9,015 Total Revenue $ 24,215 $ 24,196 Total Cost of Revenue 8,414 8,557 Gross Profit 15,801 15,638 Gross Margin % 65.3% 64.6% Total Operating Expenses 8,338 8,226 Operating Income 7,462 7,412 Operating Margin % 30.8% 30.6% Total Other (expense) income, net Pro forma pretax income 7,567 7,512 Effective tax rate 20.8% 20.0% Pro forma Net Income 5,996 6,009 Pro Forma EPS Fully Diluted $0.78 $0.77 Shares Outstanding (fully diluted) 7,730 7,779 Total Unearned Revenue - 37,604 Cash Flow from Operations 12,325 9,384 Capital Expenditures 2,392 2,500 Free cash flow 9,932 6,884 Source: Thomson Reuters, Company data, Credit Suisse estimates. Figure 22: Annual Estimates vs. Consensus (F2017) USD in millions, unless otherwise stated Annual Estimates and Guidance Variance Analysis Guidance Consensus Credit Suisse Amounts in US$millions, except per F2017E F2017E F2017E Productivity and Business Processes - 30,347 Intelligent Cloud - 27,368 More Personal Computing - 38,539 Total Revenue $ 96,240 $ 96,253 Total Cost of Revenue 34,493 34,059 Gross Profit 61,746 62,195 Gross Margin % 64.2% 64.6% Total Operating Expenses 32,900-33,000 32,575 32,967 Operating Income 29,172 29,227 Operating Margin % 30.3% 30.4% Total Other (expense) income, net Pro forma pretax income 29,893 29,985 Effective tax rate 21% (+/- 1%) 20.7% 21.0% Pro forma Net Income 23,713 23,688 Pro Forma EPS Fully Diluted $3.03 $3.03 Shares Outstanding (fully diluted) 7,819 7,829 Total Unearned Revenue - 41,250 Cash Flow from Operations 36,933 37,265 Capital Expenditures 9,064 9,196 Free cash flow 27,869 28,069 Source: Thomson Reuters, Company data, Credit Suisse estimates. Figure 23: Annual Estimates vs. Consensus (F2018) USD in millions, unless otherwise stated Annual Estimates and Guidance Variance Analysis Guidance Consensus Credit Suisse Amounts in US$millions, except per F2018E F2018E F2018E Productivity and Business Processes - 34,757 Intelligent Cloud - 30,227 More Personal Computing - 39,115 Total Revenue $ 103,701 $ 104,099 Total Cost of Revenue 37,327 37,308 Gross Profit 66,373 66,791 Gross Margin % 64.0% 64.2% Total Operating Expenses 34,594 34,756 Operating Income 31,780 32,035 Operating Margin % 30.6% 30.8% Total Other (expense) income, net Pro forma pretax income 32,114 32,435 Effective tax rate 20.5% 20.0% Pro forma Net Income 25,518 25,948 Pro Forma EPS Fully Diluted $3.32 $3.35 Shares Outstanding (fully diluted) 7,679 7,754 Total Unearned Revenue - 46,164 Cash Flow from Operations 40,154 42,443 Capital Expenditures 10,091 10,100 Free cash flow 30,064 32,343 Source: Thomson Reuters, Company data, Credit Suisse estimates. Microsoft (MSFT) 13

14 MSFT Financial Model Figure 24: Historical and Projected Income Statement and Growth Analysis US$ in millions, unless otherwise stated Fiscal 2016 by Quarter Fiscal 2017 by Quarter Fiscal 2018 by Quarter Fiscal Year Ends June Sep '15 Dec '15 Mar '16 Jun '16 Sep '16 Dec '16 Mar '17 Jun '17E Sep '17E Dec '17E Mar '18E Jun '18E E 2018E 2019E Total Revenue $ 21,660 $ 25,693 $ 22,076 $ 22,642 $ 22,334 $ 26,066 $ 23,557 $ 24,296 $ 24,196 $ 28,264 $ 25,356 $ 26,283 $ 93,580 $ 91,963 $ 96,253 $ 104,099 $ 111,516 Productivity and Business Processes 6,306 6,690 6,522 6,969 6,658 7,382 7,958 8,349 8,256 8,563 8,738 9,200 26,431 26,487 30,347 34,757 38,067 Intelligent Cloud 5,892 6,343 6,096 6,711 6,382 6,861 6,763 7,362 6,924 7,547 7,473 8,282 23,715 25,042 27,368 30,227 33,552 More Personal Computing 9,462 12,660 9,458 8,897 9,294 11,823 8,836 8,586 9,015 12,154 9,145 8,800 42,953 40,477 38,539 39,115 39,897 Operating expenses: Gross Profit $ 14,453 $ 15,821 $ 14,354 $ 14,663 $ 14,490 $ 16,165 $ 15,497 $ 16,043 $ 15,638 $ 17,356 $ 16,448 $ 17,349 60,542 59,291 62,195 66,791 72,386 % of revenue 66.7% 61.6% 65.0% 64.8% 64.9% 62.0% 65.8% 66.0% 64.6% 61.4% 64.9% 66.0% 64.7% 64.5% 64.6% 64.2% 64.9% Research and development 2,962 2,900 2,980 3,146 3,106 3,062 3,355 3,402 3,387 3,250 3,296 3,417 12,046 11,988 12,925 13,351 13,859 % of revenue 13.7% 11.3% 13.5% 13.9% 13.9% 11.7% 14.2% 14.0% 14.0% 11.5% 13.0% 13.0% 12.9% 13.0% 13.4% 12.8% 12.4% Sales and marketing 3,333 3,960 3,406 3,998 3,233 4,071 3,879 4,276 3,629 4,358 4,125 4,573 15,713 14,697 15,459 16,685 17,539 % of revenue 15.4% 15.4% 15.4% 17.7% 14.5% 15.6% 16.5% 17.6% 15.0% 15.4% 16.3% 17.4% 16.8% 16.0% 16.1% 16.0% 15.7% General and administrative 1,084 1,038 1,140 1,301 1, ,202 1,458 1,210 1,187 1,141 1,183 4,611 4,563 4,584 4,721 4,835 % of revenue 5.0% 4.0% 5.2% 5.7% 4.7% 3.4% 5.1% 6.0% 5.0% 4.2% 4.5% 4.5% 4.9% 5.0% 4.8% 4.5% 4.3% Total Operating Expenses 7,379 7,898 7,526 8,445 7,384 8,012 8,436 9,135 8,226 8,795 8,562 9,173 32,370 31,248 32,967 34,756 36,233 Operating Income 7,074 7,923 6,828 6,218 7,106 8,153 7,061 6,907 7,412 8,560 7,886 8,176 28,172 27,935 29,227 32,035 36,153 Operating Margin % 32.7% 30.8% 30.9% 27.5% 31.8% 31.3% 30.0% 28.4% 30.6% 30.3% 31.1% 31.1% 30.1% 30.4% 30.4% 30.8% 32.4% Stock options compensation expense ,574 2,668 3,082 3,123 3,345 % of revenue 3.1% 2.6% 3.0% 2.9% 3.1% 2.9% 3.7% 3.0% 3.0% 3.0% 3.0% 3.0% 2.8% 2.9% 3.2% 3.0% 3.0% Interest and other, net (280) (171) (247) (431) Pretax income 6,794 7,752 6,581 6,485 7,206 8,339 7,383 7,057 7,512 8,660 7,986 8,276 28,518 27,504 29,985 32,435 36,553 Pro forma taxes 1,414 1,477 1,608 1,001 1,217 1,824 1,668 1,588 1,502 1,732 1,597 1,655 6,831 5,176 6,297 6,487 7,311 Effective tax rate 20.8% 19.1% 24.4% 15.4% 16.9% 21.9% 22.6% 22.5% 20.0% 20.0% 20.0% 20.0% 24.0% 18.8% 21.0% 20.0% 20.0% Pro forma net income $ 5,380 $ 6,275 $ 4,973 $ 5,484 $ 5,989 $ 6,515 $ 5,715 $ 5,469 $ 6,009 $ 6,928 $ 6,389 $ 6,621 $ 21,687 $ 22,328 $ 23,688 $ 25,948 $ 29,242 Pro forma net margin 24.8% 24.4% 22.5% 24.2% 26.8% 25.0% 24.3% 22.5% 24.8% 24.5% 25.2% 25.2% 23.2% 24.3% 24.6% 24.9% 26.2% Pro forma EPS (fully-diluted) $0.67 $0.78 $0.62 $0.69 $0.76 $0.83 $0.73 $0.70 $0.77 $0.89 $0.82 $0.86 $2.63 $2.79 $3.03 $3.35 $3.80 Fiscal 2016 by Quarter Fiscal 2017 by Quarter Fiscal 2018 by Quarter Fiscal Year Ends June Sep '15 Dec '15 Mar '16 Jun '16 Sep '16 Dec '16 Mar '17 Jun '17E Sep '17E Dec '17E Mar '18E Jun '18E E 2018E 2019E Sequential growth Revenue (2.3)% 18.6% (14.1)% 2.6% (1.4)% 16.7% (9.6)% 3.1% (0.4)% 16.8% (10.3)% 3.7% 7.8% (1.7)% 4.7% 8.2% 7.1% Productivity and Business Processes (5.3)% 6.1% (2.5)% 6.9% (4.5)% 10.9% 7.8% 4.9% (1.1)% 3.7% 2.0% 5.3% (2.0)% 0.2% 14.6% 14.5% 9.5% Intelligent Cloud (6.4)% 7.7% (3.9)% 10.1% (4.9)% 7.5% (1.4)% 8.9% (5.9)% 9.0% (1.0)% 10.8% 9.1% 5.6% 9.3% 10.4% 11.0% More Personal Computing 2.8% 33.8% (25.3)% (5.9)% 4.5% 27.2% (25.3)% (2.8)% 5.0% 34.8% (24.8)% (3.8)% 11.8% (5.8)% (4.8)% 1.5% 2.0% Gross Profit (1.8)% 9.5% (9.3)% 2.2% (1.2)% 11.6% (4.1)% 3.5% (2.5)% 11.0% (5.2)% 5.5% 1.1% (2.1)% 4.9% 7.4% 8.4% Research and development (4.3)% (2.1)% 2.8% 5.6% (1.3)% (1.4)% 9.6% 1.4% (0.4)% (4.0)% 1.4% 3.7% 5.8% (0.5)% 7.8% 3.3% 3.8% Sales and marketing (15.9)% 18.8% (14.0)% 17.4% (19.1)% 25.9% (4.7)% 10.2% (15.1)% 20.1% (5.4)% 10.9% (0.6)% (6.5)% 5.2% 7.9% 5.1% General and administrative (14.8)% (4.2)% 9.8% 14.1% (19.7)% (15.9)% 36.7% 21.3% (17.0)% (1.9)% (3.9)% 3.7% (4.4)% (1.0)% 0.5% 3.0% 2.4% Total operating expenses (11.4)% 7.0% (4.7)% 12.2% (12.6)% 8.5% 5.3% 8.3% (9.9)% 6.9% (2.7)% 7.1% 1.1% (3.5)% 5.5% 5.4% 4.2% Operating income 10.8% 12.0% (13.8)% (8.9)% 14.3% 14.7% (13.4)% (2.2)% 7.3% 15.5% (7.9)% 3.7% 1.0% (0.8)% 4.6% 9.6% 12.9% Pro forma pretax income 1.7% 14.1% (15.1)% (1.5)% 11.1% 15.7% (11.5)% (4.4)% 6.4% 15.3% (7.8)% 3.6% 2.0% (3.6)% 9.0% 8.2% 12.7% Pro forma net income 6.2% 16.6% (20.7)% 10.3% 9.2% 8.8% (12.3)% (4.3)% 9.9% 15.3% (7.8)% 3.6% (4.2)% 3.0% 6.1% 9.5% 12.7% Pro forma EPS (fully-diluted) 7.1% 17.2% (20.3)% 11.1% 9.9% 9.4% (12.1)% (4.1)% 10.1% 15.5% (7.6)% 3.9% (2.7)% 6.2% 8.4% 10.6% 13.7% Year-over-year growth Revenue (6.6)% (2.9)% 1.6% 2.1% 3.1% 1.5% 6.7% 7.3% 8.3% 8.4% 7.6% 8.2% Productivity and Business Processes (2.8)% (1.9)% 1.0% 4.6% 5.6% 10.3% 22.0% 19.8% 24.0% 16.0% 9.8% 10.2% Intelligent Cloud 7.6% 5.0% 3.3% 6.6% 8.3% 8.2% 10.9% 9.7% 8.5% 10.0% 10.5% 12.5% More Personal Computing (15.8)% (4.1)% 1.6% (3.3)% (1.8)% (6.6)% (6.6)% (3.5)% (3.0)% 2.8% 3.5% 2.5% Gross Profit (3.2)% (3.1)% (1.5)% (0.3)% 0.3% 2.2% 8.0% 9.4% 7.9% 7.4% 6.1% 8.1% Research and development (3.4)% (0.1)% (0.1)% 1.7% 4.9% 5.6% 12.6% 8.1% 9.1% 6.2% (1.7)% 0.4% Sales and marketing (10.6)% (8.2)% (8.2)% 0.9% (3.0)% 2.8% 13.9% 7.0% 12.3% 7.0% 6.3% 6.9% General and administrative (5.8)% (5.4)% 4.5% 2.3% (3.6)% (15.3)% 5.4% 12.1% 15.8% 35.1% (5.1)% (18.9)% Total operating expenses (7.1)% (5.0)% (3.3)% 1.4% 0.1% 1.4% 12.1% 8.2% 11.4% 9.8% 1.5% 0.4% Operating income 1.3% (1.2)% 0.6% (2.6)% 0.5% 2.9% 3.4% 11.1% 4.3% 5.0% 11.7% 18.4% Pro forma pretax income (3.4)% (4.2)% (1.9)% (2.9)% 6.1% 7.6% 12.2% 8.8% 4.2% 3.9% 8.2% 17.3% Pro forma net income (5.3)% (2.5)% (3.9)% 8.2% 11.3% 3.8% 14.9% (0.3)% 0.3% 6.3% 11.8% 21.1% Pro forma EPS (fully-diluted) (1.9)% 0.7% (0.9)% 11.1% 14.0% 6.5% 17.5% 1.4% 1.6% 7.3% 12.8% 22.1% Microsoft (MSFT) 14

15 Figure 25: Historical and Projected Cash Flow Statement US$ in millions, unless otherwise stated Fiscal 2016 by Quarter Fiscal 2017 by Quarter Fiscal 2018 by Quarter Fiscal Year Ends June Sep '15 Dec '15 Mar '16 Jun '16 Sep '16 Dec '16 Mar '17 Jun '17E Sep '17E Dec '17E Mar '18E Jun '18E E 2018E 2019E CASH FLOWS FROM OPERATING ACTIVITIES: Net Income (GAAP) 4,902 4,998 3,756 3,122 4,690 5,200 4,801 5,999 6,385 7,361 6,788 7,035 12,193 16,778 20,690 27,569 31,069 Depreciation, amortization, and other 1,461 1,544 1,707 1,910 1,816 2,166 2,453 2,551 2,420 2,487 2,586 2,655 5,957 6,622 8,986 10,148 10,649 Stock-based compensation ,574 2,668 3,082 3,123 3,345 Net recognized losses (gains) on investments (439) (311) (652) (590) (443) (223) (1,553) - - Excess tax benefits from stock-based compensation - (20) (524) (20) Deferred income taxes 73 (247) 351 (625) 15 (587) (777) (448) (1,349) - - Deferral of unearned revenue 10,423 12,570 13,073 21,006 12,583 14,141 15, ,072 57,072 42, Recognition of unearned revenue (11,355) (11,929) (12,210) (13,004) (12,904) (13,645) (14,941) (44,920) (48,498) (41,490) - - Other , Changes in working capital 2,597 (2,026) 2,953 (4,800) 4,957 (1,097) 2,836 (516) (147) (1,641) 3,994 (603) 1,513 (1,276) 6,180 1,603 2,454 Cash Flow from Operations 8,876 5,598 10,367 8,464 11,549 6,293 10,660 8,763 9,384 9,055 14,129 9,875 29,144 33,305 37,265 42,443 47,518 CASH FLOWS FROM INVESTING ACTIVITIES: Capital Expenditures (1,356) (2,024) (2,308) (2,655) (2,163) (1,988) (1,695) (3,350) (2,500) (2,500) (2,550) (2,550) (5,944) (8,343) (9,196) (10,100) (10,810) Free Cash Flow 7,520 3,574 8,059 5,809 9,386 4,305 8,965 5,413 6,884 6,555 11,579 7,325 23,200 24,962 28,069 32,343 36,708 Acquisitions, net of cash (390) (381) (559) (63) (24) (24,760) (802) (3,723) (1,393) (25,586) - - Purchases of investments (37,570) (34,750) (27,341) (30,097) (57,181) (46,775) (43,918) (98,729) (129,758) (147,874) - - Maturities of investments 5,686 5,351 5,192 5,825 8,659 8,715 4, ,013 22,054 22, Sales of investments 28,502 28,191 19,599 16,995 32,323 48,987 36, ,848 93, , Securities lending payable (66) (78) (84) 1,070 (1,080) (466) 203 (94) - - Cash Flow from Investing (5,066) (3,328) (5,483) (10,073) (18,470) (14,751) (6,191) (3,350) (2,500) (2,500) (2,550) (2,550) (23,001) (23,950) (42,762) (10,100) (10,810) CASH FLOWS FROM FINANCING ACTIVITIES: Proceeds (repayments) of short-term debt, net 4,890 (7,031) 2,622 6,714 (3,390) (3,755) (1,302) ,481 7,195 (8,447) - - Proceeds from debt, maturities longer than 90 days , ,977 17, ,680 13,884 42, Repayments of debt, maturities longer than 90 days (1,750) (121) (900) (25) (225) (4,118) (211) (1,500) (2,796) (4,554) - - Common stock issued Common stock repurchased (4,757) (3,678) (3,857) (3,677) (4,362) (3,599) (2,062) (3,576) (3,416) (3,297) (3,182) (3,633) (14,443) (15,969) (13,599) (13,528) (15,123) Common stock cash dividends paid (2,475) (2,868) (2,842) (2,821) (2,800) (3,024) (3,012) (3,001) (3,219) (3,207) (3,194) (3,182) (9,882) (11,006) (11,837) (12,802) (13,500) Excess tax benefits from stock-based compensation Other (178) (65) (123) (3) (112) 312 (375) (369) (175) - - Cash Flow from Financing (3,930) (498) (4,916) ,329 3,016 (6,236) (6,577) (6,635) (6,503) (6,376) (6,815) (9,144) (8,373) 4,532 (26,330) (28,623) Foreign currency exchange rate impact on cash (44) (18) 17 (22) 10 (18) (73) (67) Net Increase in Cash and Cash Equivalents (164) 1,754 (15) (660) 7,418 (5,460) (1,755) (1,164) , (3,074) 915 (961) 6,013 8,084 Cash and Cash Equivalents, beginning of period 5,595 5,431 7,185 7,170 6,510 13,928 8,468 6,713 5,549 5,798 5,849 11,052 8,669 5,595 6,510 5,549 11,562 Cash and Cash Equivalents, end of period 5,431 7,185 7,170 6,510 13,928 8,468 6,713 5,549 5,798 5,849 11,052 11,562 5,595 6,510 5,549 11,562 19,646 Figure 26: Historical and Projected Balance Sheet US$ in millions, unless otherwise stated Fiscal 2016 by Quarter Fiscal 2017 by Quarter Fiscal 2018 by Quarter Fiscal Year Ends June Sep '15 Dec '15 Mar '16 Jun '16 Sep '16 Dec '16 Mar '17 Jun '17E Sep '17E Dec '17E Mar '18E Jun '18E E 2018E 2019E Current assets Cash and cash equivalents 5,431 7,185 7,170 6,510 13,928 8,468 6,713 5,549 5,798 5,849 11,052 11,562 5,595 6,510 5,549 11,562 19,646 Short-term investments 93,924 95,455 98, , , , , , , , , ,305 90, , , , ,305 Accounts receivable, net 11,444 14,507 12,247 18,277 11,129 14,343 12,882 19,707 12,098 17,273 15,214 22,779 17,908 18,277 19,707 22,779 24,450 Inventories 3,816 2,702 2,450 2,251 3,122 1,961 1,979 2,293 3,423 2,182 2,177 2,482 2,902 2,251 2,293 2,482 2,582 Deferred incomes taxes 1,447 1,618 1, , Other current assets 5,594 6,345 6,598 5,892 6,726 5,864 5,434 6,187 7,062 6,157 5,706 6,496 5,461 5,892 6,187 6,496 6,821 Total current assets 121, , , , , , , , , , , , , , , , ,804 Long-term investments Property and equipment, net 15,046 15,789 16,831 18,356 19,224 21,379 21,962 22,761 22,841 22,854 22,818 22,713 14,731 18,356 22,761 22,713 22,874 Equity and other investments 11,438 11,514 11,315 10,431 10,486 8,912 7,381 7,381 7,381 7,381 7,381 7,381 12,053 10,431 7,381 7,381 7,381 Goodwill 17,142 17,436 17,948 17,872 17,907 34,524 34,668 34,668 34,668 34,668 34,668 34,668 16,939 17,872 34,668 34,668 34,668 Intangible assets, net 4,745 4,619 4,459 3,733 3,522 11,001 10,547 10,547 10,547 10,547 10,547 10,547 4,835 3,733 10,547 10,547 10,547 Deferred incomes taxes Other long-term assets 2,869 2,928 2,895 3,642 3,476 3,845 4,146 4,146 4,146 4,146 4,146 4,146 2,953 3,642 4,146 4,146 4,146 Total assets 172, , , , , , , , , , , , , , , , ,420 Current liabilities Accounts payable 6,630 6,936 6,759 6,898 6,296 6,580 6,217 7,153 6,846 6,666 6,335 7,246 6,591 6,898 7,153 7,246 7,540 Short-term debt 10,748 3,750 5,498 12,904 14,536 25,664 7,786 7,786 7,786 7,786 7,786 7,786 7,484 12,904 7,786 7,786 7,786 Accrued compensation 3,450 3,649 4,276 5,264 3,621 3,982 4,604 5,527 3,730 4,101 4,742 5,693 5,096 5,264 5,527 5,693 5,864 Income taxes Short-term unearned revenue 21,603 20,929 20,876 27,468 26,304 26,085 26,518 31,588 29,592 29,346 29,833 35,537 23,223 27,468 31,588 35,537 39,090 Other 6,361 6,886 6,260 6,243 7,333 7,968 6,226 6,226 6,226 6,226 6,226 6,226 6,858 6,243 6,226 6,226 6,226 Total current liabilities 49,399 42,643 44,354 59,357 58,810 70,787 52,005 58,934 54,834 54,779 55,576 63,142 49,858 59,357 58,934 63,142 67,160 Long-term liabilities Long-term debt 27,819 40,679 40,896 40,783 60,154 59,306 76,222 76,222 76,222 76,222 76,222 76,222 27,808 40,783 76,222 76,222 76,222 Long-term unearned revenue 2,784 4,102 5,017 6,441 7,284 8,595 9,215 9,662 8,012 9,455 10,137 10,628 2,095 6,441 9,662 10,628 11,159 Deferred income taxes 2,169 2,194 2, ,564 1, , Other long-term liabilities 13,280 13,700 14,122 14,420 14,340 15,980 17,381 17,381 17,381 17,381 17,381 17,381 13,544 14,420 17,381 17,381 17,381 Total liabilities 95, , , , , , , , , , , ,837 96, , , , ,387 Total stockholders' equity 77,445 76,780 74,806 71,997 70,372 68,809 69,729 69,880 70,355 72,061 73,233 74,242 80,083 71,997 69,880 74,242 80,033 Total liabilities and stockholders' equity 172, , , , , , , , , , , , , , , , ,420 Microsoft (MSFT) 15

16 MSFT Valuation Figure 27: MSFT Discounted Cash Flow US$ in millions, unless otherwise stated F2016 F2017E F2018E F2019E F2020E F2021E F2022E F2023E F2024E F2025E F2026E 10-Year CAGR Total revenue $91,963 $96,253 $104,099 $111,516 $119,144 $126,967 $134,971 $143,138 $151,454 $159,901 $168, % % growth y-o-y 4.7% 8.2% 7.1% 6.8% 6.6% 6.3% 6.1% 5.8% 5.6% 5.4% EBITDA $34,557 $38,213 $42,183 $46,802 $50,791 $54,984 $59,379 $63,979 $68,782 $73,789 $78, % EBITDA margin 37.6% 39.7% 40.5% 42.0% 42.6% 43.3% 44.0% 44.7% 45.4% 46.1% 46.9% % growth y-o-y 10.6% 10.4% 11.0% 8.5% 8.3% 8.0% 7.7% 7.5% 7.3% 7.1% EBIT $27,935 $29,227 $32,035 $36,153 $39,414 $42,859 $46,491 $50,310 $54,319 $58,519 $62, % Operating margin 30.4% 30.4% 30.8% 32.4% 33.1% 33.8% 34.4% 35.1% 35.9% 36.6% 37.3% % growth y-o-y 4.6% 9.6% 12.9% 9.0% 8.7% 8.5% 8.2% 8.0% 7.7% 7.5% Cash tax rate 18.8% 21.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% EBIT * (1-Tax) $22,678 $23,089 $25,628 $28,922 $31,531 $34,287 $37,193 $40,248 $43,456 $46,815 $50, % + D&A 6,622 8,986 10,148 10,649 11,377 12,125 12,889 13,669 14,463 15,269 16,087 % of revenue 7.2% 9.3% 9.7% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% 9.5% - CapEx and CapContent (8,343) (9,196) (10,100) (10,810) (11,490) (12,181) (12,881) (13,589) (14,303) (15,021) (15,741) % of revenue 9.1% 9.6% 9.7% 9.7% 9.6% 9.6% 9.5% 9.5% 9.4% 9.4% 9.3% + WC (1,276) 6,180 1,603 2,454 4,036 4,237 4,437 4,634 4,827 5,016 5,201 % of revenue -1.4% 6.4% 1.5% 2.2% 3.4% 3.3% 3.3% 3.2% 3.2% 3.1% 3.1% ufcf $19,681 $29,060 $27,279 $31,215 $35,454 $38,468 $41,637 $44,962 $48,443 $52,081 $55, % % growth y-o-y 47.7% -6.1% 14.4% 13.6% 8.5% 8.2% 8.0% 7.7% 7.5% 7.3% Shares 8,002 7,829 7,754 7,686 7,618 7,550 7,482 7,414 7,346 7,278 7,210 % growth y-o-y (dilution rate) 8.7% 8.1% 7.4% 6.9% 6.4% 5.9% 5.5% 5.2% 4.8% 4.6% 4.3% UFCF/share $2.46 $3.71 $3.52 $4.06 $4.65 $5.10 $5.57 $6.06 $6.59 $7.16 $ % % growth y-o-y 50.9% -5.2% 15.4% 14.6% 9.5% 9.2% 9.0% 8.7% 8.5% 8.3% F2017E F2018E F2019E F2020E F2021E F2022E F2023E F2024E F2025E F2026E Last Reported Quarter F2017 Q3 Discount multiplier with WACC = 10.1% Quarter September 0% Quarter December 0% Quarter March 0% Quarter June Year PV of ufcf $7,093 $25,091 $26,085 $26,917 $26,533 $26,091 $25,597 $25,055 $24,473 $23,854 Price Per Share F2017 Q3 Valuation Sensitivity Short Term Discount Rate - WACC Total PV of Projected FCF $236,788 $ % 9.07% 10.07% 11.07% 12.07% PV of Terminal Value $310, % Total PV of Operations (Enterprise Value) $547, % Plus: Cash $126, % Less: Debt (mrq) -$84, % Equity Value $589, % Shares Outstanding 7,813 8 Current Value Per Share $75.39 Risk / Reward 8.07% 9.07% 10.07% 11.07% 12.07% 12-month Price Per Share $ % 17.1% 10.4% 4.2% -1.5% -6.7% Current Share Price $71.77 $ % 23.6% 16.4% 9.7% 3.6% -2.1% Discount / Premium to Current Value 5.0% 16.6% 3.00% 31.7% 23.8% 16.6% 9.9% 3.8% 4.00% 42.1% 33.5% 25.5% 18.1% 11.4% Cost of Equity F2017 Q3 F2026E 5.00% 56.1% 46.3% 37.3% 29.1% 21.5% Risk Free Rate 0.20% 2.00% Beta Risk Premium 10.00% 10.00% Cost of Equity 11.00% 12.00% WACC F2017 Q3 F2026E Equity Value (M) $574,304 Debt $84,008 Debt / Equity 15% 15.00% Cost of Debt 6.00% 6.00% Tax Rate 22.6% 20.0% Net Cost of Debt 4.64% 4.80% WACC 10.07% 10.92% Terminal Multiple F2026E Perpetual Growth Rate 3.00% 3.00% WACC 10.92% Terminal Multiple (1/(WACC-g)) 12.6x 1-year Forward Multiples EV / Revenue 5.7x EV / EBITDA 14.3x EV / ufcf 18.8x ufcf Yield 5.17% Growth % Upside / Downside to Current Price Source: Thomson Reuters, Company data, Credit Suisse estimates. Microsoft (MSFT) 16