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M A B D E F G H | J L 43 Using the Investment Thesis to Craft a Financial Forecast 44 As described in 'Developing a Forecast', financial analysts develop the financial forecast to reflect their investment Thesis. 45 Analysts cast a 'Judgmental Forecast' expressing a point of view communicated through an explicit quantitative model as described in Row 66 in 'Intro to Forecasting'. 46 Below is the summary of the Credit Suisse financial forecast for Microsoft as presented alongside the Investment Thesis we showed you earlier. 47 48 Microsoft (MSFT) 49 50 Price (29 Jan 2020): US$168.04 Target Price: (from 180.00) 190.00 Income Statement 6/18A 6/19A 6/20E 6/21E 51 Revenue (US$ m) () 110.360.0 125.843.0 141,477.4 154.292.7 Sales 110.360.0 125.843.0 141.477.4 154,292.7 52 EBITDA 45,317.8 54,639.9 63.857.8 69.418.4 Operating profit 35,056.8 42.957.9 51.090.0 54,922.2 53 Recurring profit 36.472.8 43.686.9 51.284.0 55,122.2 Cash Flow 6/18A 6/19A 6/20E 6/21E 54 Cash flow from operations 43,884 52,185 55,324 60.716 CAPEX (11,632) (13,925) (16,226) (20,080) 55 Free cashflow to the firm 32.252 38,260 39.098 40.636 Cash flow from investments (6.061) (15.773) (17.108) (20.080) 56 Net share issue(/repurchase) (9,719) (18,401) (16,896) (17,641) Dividends paid (12,699) (13,811) (15,218) (16,781) 7,183 Issuance (retirement) of debt O 0 57 O Other (18,355) (4,875) (2,271) O Cashflow from francing activities (33,500) (38,887) (34 385) 58 (34,400) Effect of exchange rates 34 (115) (54) o Changes in Net Cash/Debt 14.237 3,472 6.347 6.234 59 Net debt at end 64294 80,822 54 475 48 241 Balance Sheet ($US) 6/18A 6/19A 6/20E 6/21E 60 Assets Other current assets 128,573 132,609 134.687 135,487 61 Total current assets 169,662 175,552 184,465 196.244 Total assets 258.848 286,556 302.887 320.250 62 Liabilities Short-term debt 3,998 5,516 6.247 6,247 63 Total current abilities 58,488 69,420 68,917 72,634 Long-term debt 72,242 86,662 63,381 63,361 64 Total liabilities 176,130 184.226 182.245 185,416 Shareholder equity 82,718 102,330 120,642 134,834 65 Total liabilities and equity 258,848 286,556 302,887 320,250 Net debt 64,294 60,822 54,475 48.241 66 Per share 6/18A 6/19A 6/20E 6/21E No. of shares (wid avg) 7,792 7,752 7,684 7,618 67 CS adj. EPS 3.88 4.75 5.53 5.90 Prev. EPS (US$) 5.23 5.78 68 Dividend (US$) 0.00 0.00 0.00 0.00 Free cash flow per share 4.14 4.94 5.09 5.33 69 Earnings 6/18A 6/19A 6/20E 6/21E Sales growth (%) 14.3 14.0 12.4 9.1 70 Net profit growth (%) 17.6 21.7 15.5 5.7 EPS growth (%) 182 22.1 15.0 5.7 71 EBIT margin(96) 31.8 34.1 36.1 35.6 Valuation 6/18A 6/19A 6/20E 6/21E 72 EV/Sales 12.20 10.67 9.45 8.62 EV/EBIT) 38.4 31.3 26.2 242 73 P/E) 43.3 35.4 30.4 28.5 Quarterly EPS a1 02 03 04 74 2019A 1.14 1.10 1.14 1.37 2020E 1.38 1.51 1.30 1.34 75 2021E 1.54 1.39 1.53 1.43 A B D E F G H | J L M N 78 Assignment 2: Bullish Forecast 79 You are a Wall Street Microsoft analyst looking to make a name for yourself as a Microsoft Bull. 80 Implement a growth and profitability outlook greater than the Credit Suisse analyst. 81 OpEx is expected to decline as a percentage of revenues due to 'Scale Economies'. 82 In light of your bullish scenario, gross margins may rise as there are positive gains in the faster growing Azure cloud business. 83 Leave the model's default assumptions for Depreciation, Amortization, Net Interest, Other Income and Taxes as they are, equal to the prior year's figures. 84 Use the SFAM 'Income Statement(GAAP)' to make these forecasts in column AH for 2020E. 85 86 Inputs 87 - Revenue Growth: 23% 88 - Gross Margins: 66% 89 - OpEx Percent of Revenues*: 30% 90 91 *HINTS: 92 - There is no 'yellow' box in SFAM to insert the answer for OpEx. 93 - We are reconstructing the environment you will encounter when working as a financial analyst. 94 - When financial analysts receive 'guidance from companies, they are often given a generalization such as 'spending levels will be roughly the same' or 'OpEx will be roughly 30%'. 95 - Like a working financial analyst, your job here is to adjust the R&D and SG&A figures until the forecast meets the guidance that OpEx is equal to 30%. 96 - There is no right or wrong answer for the components of Opex, but a working financial analyst would assure the individual line items make 'sense'. 97 What does that mean? If the prior two numbers were 10% and 8%, the next figure is unlikely to be 20% unless there is a major change occurring. 98 99 Leaving all other assumptions the same, what is your expectation for EBIT margins for 2020E? 100 101 102 What is your EPS and where is it versus the consensus average for GAAP EPS of $5.66 for 2020E? 103 104 N B C D E F G H I J L M 105 Assignment 3: Bearish Forecast 106 A bearish forecast is one that is below the consensus average and shows a deterioration in trends. 107 108 Microsoft recently issued a press release saying that it would not meet prior guidance for FQ3/March 2020. 109 "On Jan. 29, as part of our second quarter of fiscal year 2020 earnings call, we issued quarterly revenue guidance for our More Personal Computing segment 110 between $10.75 and $11.15 billion, which included a wider than usual range to reflect uncertainty related to the public health situation in China. 111 Although we see strong Windows demand in line with our expectations, the supply chain is returning to normal operations at a slower pace than anticipated 112 at the time of our Q2 earnings call. As a result, for the third quarter of fiscal year 2020, we do not expect to meet our More Personal Computing segment 113 guidance as Windows OEM and Surface are more negatively impacted than previously anticipated. All other components of our Q3 guidance remain unchanged." 114 115 You are 'bearish' and have great concerns that these negative trends will persist. 116 What is the best choice of growth rates to demonstrate your negative outlook ? 117 -10% this exercise sucks because there is no right answer 118 119 You decide to stick your neck out and make a major call on Microsoft's stock. 120 Implement a very negative forecast below expectations. Here, you expect Gross Margins to decline and OpEx to be lower, as the company cuts back in its spending. 121 Use the SFAM 'Income Statement(GAAP)' and insert these forecasts into the yellow forecast boxes in column AH for 2020E. 122 Revenue Growth 10% 123 Gross Margins 62% 124 OpEx Percent of Revenues 33% 125 126 Are your EBIT margins higher or lower than in the Bullish forecast above (Row 100)? 127 128 129 What is your EPS forecast? 130 Please choose the closest figure for Fully Diluted Earnings per Share in the 'Income Statement (GAAP)' Sheet. 131 132 A B C D E F H I 133 Assignment 4: Consensus Forecast 134 135 of 34 analysts publishing on Microsoft's shares, the following is the consensus estimate. 136 137 Low High Mean 138 2020E 139 Revenues $B 139.4 152.0 142.2 140 EPS 5.46 6.00 5.66 141 2021E 142 Revenues $B 153.2 168.7 159.7 143 EPS 5.52 7.11 6.30 144 Source: CNN Money, 3/16/20 145 146 Use the SFAM IS Model to build a forecast for 2020E and 2021E that meet the consensus. 147 Hints: 148 First, adjust the Revenue growth rate in the SFAM model that sets the Revenues to match the consensus. 149 (Remember the consensus above is in $Billions and the SFAM model is expressed in $Millions.) 150 Second, alter the figures for R&D and SG&A until the EPS matches the consensus forecast. 151 Do not touch any of the other variables in the model. 152 153 What is your EBIT forecast in $Bs for 2020E? (This means you should enter '10' for $10 billion.) 154 155 156 What is your EBIT forecast in $Bs for 2021E? 157 158 159 What revenue growth rate would you expect to see for 2022E? 160 161 M A B D E F G H | J L 43 Using the Investment Thesis to Craft a Financial Forecast 44 As described in 'Developing a Forecast', financial analysts develop the financial forecast to reflect their investment Thesis. 45 Analysts cast a 'Judgmental Forecast' expressing a point of view communicated through an explicit quantitative model as described in Row 66 in 'Intro to Forecasting'. 46 Below is the summary of the Credit Suisse financial forecast for Microsoft as presented alongside the Investment Thesis we showed you earlier. 47 48 Microsoft (MSFT) 49 50 Price (29 Jan 2020): US$168.04 Target Price: (from 180.00) 190.00 Income Statement 6/18A 6/19A 6/20E 6/21E 51 Revenue (US$ m) () 110.360.0 125.843.0 141,477.4 154.292.7 Sales 110.360.0 125.843.0 141.477.4 154,292.7 52 EBITDA 45,317.8 54,639.9 63.857.8 69.418.4 Operating profit 35,056.8 42.957.9 51.090.0 54,922.2 53 Recurring profit 36.472.8 43.686.9 51.284.0 55,122.2 Cash Flow 6/18A 6/19A 6/20E 6/21E 54 Cash flow from operations 43,884 52,185 55,324 60.716 CAPEX (11,632) (13,925) (16,226) (20,080) 55 Free cashflow to the firm 32.252 38,260 39.098 40.636 Cash flow from investments (6.061) (15.773) (17.108) (20.080) 56 Net share issue(/repurchase) (9,719) (18,401) (16,896) (17,641) Dividends paid (12,699) (13,811) (15,218) (16,781) 7,183 Issuance (retirement) of debt O 0 57 O Other (18,355) (4,875) (2,271) O Cashflow from francing activities (33,500) (38,887) (34 385) 58 (34,400) Effect of exchange rates 34 (115) (54) o Changes in Net Cash/Debt 14.237 3,472 6.347 6.234 59 Net debt at end 64294 80,822 54 475 48 241 Balance Sheet ($US) 6/18A 6/19A 6/20E 6/21E 60 Assets Other current assets 128,573 132,609 134.687 135,487 61 Total current assets 169,662 175,552 184,465 196.244 Total assets 258.848 286,556 302.887 320.250 62 Liabilities Short-term debt 3,998 5,516 6.247 6,247 63 Total current abilities 58,488 69,420 68,917 72,634 Long-term debt 72,242 86,662 63,381 63,361 64 Total liabilities 176,130 184.226 182.245 185,416 Shareholder equity 82,718 102,330 120,642 134,834 65 Total liabilities and equity 258,848 286,556 302,887 320,250 Net debt 64,294 60,822 54,475 48.241 66 Per share 6/18A 6/19A 6/20E 6/21E No. of shares (wid avg) 7,792 7,752 7,684 7,618 67 CS adj. EPS 3.88 4.75 5.53 5.90 Prev. EPS (US$) 5.23 5.78 68 Dividend (US$) 0.00 0.00 0.00 0.00 Free cash flow per share 4.14 4.94 5.09 5.33 69 Earnings 6/18A 6/19A 6/20E 6/21E Sales growth (%) 14.3 14.0 12.4 9.1 70 Net profit growth (%) 17.6 21.7 15.5 5.7 EPS growth (%) 182 22.1 15.0 5.7 71 EBIT margin(96) 31.8 34.1 36.1 35.6 Valuation 6/18A 6/19A 6/20E 6/21E 72 EV/Sales 12.20 10.67 9.45 8.62 EV/EBIT) 38.4 31.3 26.2 242 73 P/E) 43.3 35.4 30.4 28.5 Quarterly EPS a1 02 03 04 74 2019A 1.14 1.10 1.14 1.37 2020E 1.38 1.51 1.30 1.34 75 2021E 1.54 1.39 1.53 1.43 A B D E F G H | J L M N 78 Assignment 2: Bullish Forecast 79 You are a Wall Street Microsoft analyst looking to make a name for yourself as a Microsoft Bull. 80 Implement a growth and profitability outlook greater than the Credit Suisse analyst. 81 OpEx is expected to decline as a percentage of revenues due to 'Scale Economies'. 82 In light of your bullish scenario, gross margins may rise as there are positive gains in the faster growing Azure cloud business. 83 Leave the model's default assumptions for Depreciation, Amortization, Net Interest, Other Income and Taxes as they are, equal to the prior year's figures. 84 Use the SFAM 'Income Statement(GAAP)' to make these forecasts in column AH for 2020E. 85 86 Inputs 87 - Revenue Growth: 23% 88 - Gross Margins: 66% 89 - OpEx Percent of Revenues*: 30% 90 91 *HINTS: 92 - There is no 'yellow' box in SFAM to insert the answer for OpEx. 93 - We are reconstructing the environment you will encounter when working as a financial analyst. 94 - When financial analysts receive 'guidance from companies, they are often given a generalization such as 'spending levels will be roughly the same' or 'OpEx will be roughly 30%'. 95 - Like a working financial analyst, your job here is to adjust the R&D and SG&A figures until the forecast meets the guidance that OpEx is equal to 30%. 96 - There is no right or wrong answer for the components of Opex, but a working financial analyst would assure the individual line items make 'sense'. 97 What does that mean? If the prior two numbers were 10% and 8%, the next figure is unlikely to be 20% unless there is a major change occurring. 98 99 Leaving all other assumptions the same, what is your expectation for EBIT margins for 2020E? 100 101 102 What is your EPS and where is it versus the consensus average for GAAP EPS of $5.66 for 2020E? 103 104 N B C D E F G H I J L M 105 Assignment 3: Bearish Forecast 106 A bearish forecast is one that is below the consensus average and shows a deterioration in trends. 107 108 Microsoft recently issued a press release saying that it would not meet prior guidance for FQ3/March 2020. 109 "On Jan. 29, as part of our second quarter of fiscal year 2020 earnings call, we issued quarterly revenue guidance for our More Personal Computing segment 110 between $10.75 and $11.15 billion, which included a wider than usual range to reflect uncertainty related to the public health situation in China. 111 Although we see strong Windows demand in line with our expectations, the supply chain is returning to normal operations at a slower pace than anticipated 112 at the time of our Q2 earnings call. As a result, for the third quarter of fiscal year 2020, we do not expect to meet our More Personal Computing segment 113 guidance as Windows OEM and Surface are more negatively impacted than previously anticipated. All other components of our Q3 guidance remain unchanged." 114 115 You are 'bearish' and have great concerns that these negative trends will persist. 116 What is the best choice of growth rates to demonstrate your negative outlook ? 117 -10% this exercise sucks because there is no right answer 118 119 You decide to stick your neck out and make a major call on Microsoft's stock. 120 Implement a very negative forecast below expectations. Here, you expect Gross Margins to decline and OpEx to be lower, as the company cuts back in its spending. 121 Use the SFAM 'Income Statement(GAAP)' and insert these forecasts into the yellow forecast boxes in column AH for 2020E. 122 Revenue Growth 10% 123 Gross Margins 62% 124 OpEx Percent of Revenues 33% 125 126 Are your EBIT margins higher or lower than in the Bullish forecast above (Row 100)? 127 128 129 What is your EPS forecast? 130 Please choose the closest figure for Fully Diluted Earnings per Share in the 'Income Statement (GAAP)' Sheet. 131 132 A B C D E F H I 133 Assignment 4: Consensus Forecast 134 135 of 34 analysts publishing on Microsoft's shares, the following is the consensus estimate. 136 137 Low High Mean 138 2020E 139 Revenues $B 139.4 152.0 142.2 140 EPS 5.46 6.00 5.66 141 2021E 142 Revenues $B 153.2 168.7 159.7 143 EPS 5.52 7.11 6.30 144 Source: CNN Money, 3/16/20 145 146 Use the SFAM IS Model to build a forecast for 2020E and 2021E that meet the consensus. 147 Hints: 148 First, adjust the Revenue growth rate in the SFAM model that sets the Revenues to match the consensus. 149 (Remember the consensus above is in $Billions and the SFAM model is expressed in $Millions.) 150 Second, alter the figures for R&D and SG&A until the EPS matches the consensus forecast. 151 Do not touch any of the other variables in the model. 152 153 What is your EBIT forecast in $Bs for 2020E? (This means you should enter '10' for $10 billion.) 154 155 156 What is your EBIT forecast in $Bs for 2021E? 157 158 159 What revenue growth rate would you expect to see for 2022E? 160 161

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