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Microsoft: The Satya Nadella Era Begins

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The big tech company appoints a new CEO.

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Bye-bye, Mr. Ballmer.

This morning, as widely expected, Microsoft (NASDAQ:MSFT) promoted its Cloud and Enterprise head Satya Nadella to be just its third CEO in its 39-year history.

This really is a historic moment as Microsoft founder Bill Gates will be stepping down from the Chairman post and transitioning to a new role on the board as Founder and Technology Advisor.

But interestingly enough, according to the press release, Gates will devote more time to the company in support of Mr. Nadella. There's a chance that this is a piece of intentional misdirection to give investors the perception that Gates is not being ousted. After all, if he was going to be spending more time with Microsoft, why would he give up the Chairman role?

John Thompson, CEO of Virtual Instruments, was named as Chairman.

So why Mr. Nadella?

Would some of the other names that were floating around, like Ford's (NYSE:F) Alan Mulally and Nokia's (NYSE:NOK) Stephen Elop, have made more sense?

To answer these questions, we need some context.

The Apple (NASDAQ:AAPL) iPad drove a stake through the heart of the PC upgrade cycle upon its debut in 2010. Windows 8 has been a non-factor in the market. Add in the stunning array of Google (NASDAQ:GOOG) Android devices and emerging product classes represented by the likes of Chromebooks and you have a lot of competition for the traditional Windows PC.

Meanwhile, for all the money and efforts it has put into emerging product classes like smartphones and tablets, Microsoft just hasn't built meaningful scale.

So we have a disturbance to the historical steady growth of the PC market coupled with a lack of traction in mobile.

Now I know a lot of people are going around making obvious demands like "Make Windows better," but let's face the facts: The ground has shifted.

But Microsoft is a perennial power in enterprise software and it is aggressively moving into the cloud.

These seem like the places to be for one simple reason: They offer recurring revenues. IT departments like consistency, even if it's expensive, and Wall Street loves those steady monthly fees coming in from cloud services.

Ten years from now, aside from free or dirt-cheap apps, the vast majority of software will be sold on a subscription basis. So it's best for Microsoft to pick a leader with suitable expertise -- and that's Mr. Nadella.

As of now, Microsoft is not making a ton of dough in the cloud.

In its fiscal second quarter (the December 2013 quarter) it reported over 100% year-over-year growth in commercial cloud services revenue on growing demand for its Office 365, Azure, and Dynamics CRM Online services.

Those products (excluding Office 365 Home Premium) reside within Microsoft's "Commercial Other" segment, which accounted for $1.78 billion, or just 7.2% of revenues last quarter.

Given that the "Commercial Other" unit grew by just 28% last quarter, mathematically, the cloud business just can't be very large.

Let's do some fuzzy math. If the cloud business grew by 105% last quarter, and the the rest of the segment was flat, the cloud business would account for about $760 million in revenues, or 3% of company revenues. For comparative purposes, cloud leader Salesforce.com (NYSE:CRM) is expected to report $1.1 billion in revenues for its fourth quarter (ended in January), albeit on a smaller growth rate of 35%.

Nevertheless, it's a fast-growing market that represents where the puck is going, so it's where Microsoft's got to go, thus making Mr. Nadella the logical choice.

Additionally, from a perception perspective, Mr. Nadella's background in electrical engineering and computer science (he also has an MBA) brings legitimate nerd credibility -- something Steve Ballmer never had.

If you look at today's highest-profile tech CEOs, like Tesla's (NASDAQ:TSLA) Elon Musk, Yahoo's (NASDAQ:YHOO) Marissa Mayer, and Facebook's (NASDAQ:FB) Mark Zuckerberg, they tend to have serious technical skills.

So the choice of Mr. Nadella should help improve Microsoft's image from a pure technology standpoint, and probably help with recruiting as well.

Twitter: @MichaelComeau

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