As the computing world changes, 
Microsoft (MSFT) is a story of two companies: a lagging consumer and devices firm, and a firm whose dominance in the enterprise world is growing.
But Microsoft reported second-quarter results that were ahead of expectations, as better than anticipated devices and consumer sales combined with typically solid commercial growth to drive the outperformance. The firm was able to mitigate the effects of the continuing decline of the PC market with sales of cloud offerings, new devices, and expense controls. We are raising our fair value estimate to $39 from $38 and maintaining our wide moat (sustainable competitive advantage) rating.
Total revenue increased 14% year over year to $24.5 billion as devices and consumer revenue grew 13% to $11.9 billion, and commercial revenue grew 10% to $12.7 billion. There were several bright spots driving the top line: commercial remained strong, as key products gained share over rivals, while the holiday season saw the firm finally making some gains in consumer hardware--surface tablet sales more than doubled from the fall quarter to $893 million, and the Xbox One sold 3.9 million consoles in five weeks.
The profitability picture was mixed, as the bump in hardware sales weighed on gross margins. However, operating expense growth was slightly muted as the commercial cloud and enterprise services businesses saw improved economies of scale.
This was largely a positive quarter, as some important questions were answered: the enterprise business remains strong, hardware has shown signs of life, and the cloud businesses continue to gain scale. However, key issues remain, including the search for a new chief executive, the Windows Phone/Nokia strategy, and capital allocation decisions.
While Microsoft exited the quarter with some momentum, the uncertainty around these issues could weigh on results going forward. With decelerating sales in Nokia's handset business this past quarter, it may be more challenging for Microsoft to continue its recent smartphone share gains. Additionally, when the transaction closes later this quarter, we believe margins will be pressured owing to the heavier mix of hardware revenues. We expect the firm to pursue additional OEMs (original equipment manufacturers) to manufacture Windows Phones, as Nokia currently manufacturers approximately 90% of all Windows Phones. We believe this may involve incentives in the form of co-marketing agreements or OS licensing price incentives.
We believe the biggest overhang facing Microsoft is the prolonged search for CEO Steve Ballmer's replacement. It appears that the process has taken longer than the board originally anticipated; management did not comment on the search during the earnings' conference call. Nevertheless, we believe Microsoft's core enterprise business remains very strong, despite a tepid macro environment. The cloud-based businesses continue to gain customers with triple-digit revenue growth, while data centre products continue their usual double-digit sales gains. Given this continued strength, we still consider Microsoft a core technology holding.
