Microsoft Corp – Azure strength fuels revenue growth

 

 

The Positives

+ Azure revenue growth accelerates. In 3Q24, Intelligent Cloud segment revenue grew 21% YoY to US$26.7bn led by strength in cloud services. Azure revenue grew 31% YoY, beating the company’s guidance of 28% YoY growth. The significant growth was primarily driven by an increase in the size and duration of the deals as customers migrated workloads (e.g., SAP/Oracle) from on-premises to the cloud. Management noted accelerating demand for its Azure AI services, which contributed 7% points to Azure growth (vs. 6% in 2Q24). Azure AI services help enterprises create their own generative AI solutions, including the development of chatbots, summarization, and writing documents.

 

+ Windows and Gaming continued to rebound. In 3Q24, More Personal Computing segment revenue grew 18% YoY to US$15.6bn, 3% above the top end of company guidance. Notably, Windows OEM revenue grew by 11% YoY, beating the company’s guidance that it would be relatively flat. The growth was mainly driven by a recovery in the PC market and a shift to developed markets. Meanwhile, Gaming segment revenue grew by 51% YoY to US$5.5bn as the integration of Activision Blizzard titles like Call of Duty into Xbox Gamepass drove higher player engagement.

 

+ Improvement in margins. In 3Q24, the operating margin expanded by 300bps YoY to 45% despite elevated AI-related CAPEX, beating the company’s guidance of 43%. The margin improvement was mainly due to top-line upside, higher operating leverage from prudent headcount control (down 1% YoY), and lower sales-related costs. CAPEX jumped 66% YoY to US$11bn due to cloud and AI infrastructure build-out.

 

 

The Negatives

- Nil

Microsoft Corp – AI demand boost cloud revenue

 

 

 

The Positives

+ Azure maintained solid growth. In 2Q24, Intelligent Cloud segment revenue grew 20% YoY to US$25.9bn led by Azure and other cloud services. Azure revenue grew 28% YoY in constant currency, beating the company’s guidance range of 26% to 27% YoY growth. Management highlighted that the generative AI applications built by enterprises on Azure’s infrastructure started scaling up leading to higher usage and revenue growth. AI provided a 6% uplift to Azure’s growth in 2Q24 vs 3% in 1Q24 and was largely made up of inference workloads instead of training. Also, the number of Azure AI customers increased to 53,000 (vs 18,000 in 1Q24) and one-third of that number represents customers new to the Azure platform within the past year suggesting early traction.

 

+ Strong demand for Office 365 continues. Office 365 Commercial revenue (under productivity and business processes) grew by 16% YoY, in line with the company guidance. Consistent with previous quarters, user growth and higher average revenue per user due to E5 upsell at renewals continued to drive this business segment. Paid Office 365 Commercial users grew by 9% YoY to more than 400mn driven by demand from small and medium businesses and frontline worker offerings.

 

+ Margins continue to improve. In 2Q24, Microsoft reported an operating margin of 44% (vs 39% in 2Q23) despite elevated AI investments and the impact of the Activision acquisition. The margin improvement was mainly due to top-line upside and continued focus on higher operating leverage through disciplined cost controls (headcount down 2% YoY).

 

The Negatives

- Nil.

Microsoft Corp – Azure growth re-accelerates

 

 

The Positives

+ Azure revenue growth re-accelerates. Microsoft showed signs of recovery in its cloud-computing unit, with Azure revenue expanding 29% YoY. The growth came ahead of the company's guidance of 26% YoY growth as more enterprises move to the cloud and growing contributions from AI-enabled services (3 percentage points). Management highlighted that Azure OpenAI service now has 18,000 customers compared with 11,000 last quarter (up 60% QoQ) indicating early traction for its AI services.

 

+ Office 365 momentum continues. Office 365 commercial revenue grew by 18% YoY led by strong growth in its users and higher average revenue per user as customers upsell to E5 license for its advanced functionalities. Paid Office 365 commercial users grew by 10% YoY to approximately 400mn driven by continued demand from small and medium businesses and frontline worker offerings. We believe that the commercial launch of Office 365 AI tools  (US$30 per user per month) on Nov. 1 should enable Microsoft to maintain double-digit Office 365 growth rates.

 

+ Improvement in margins. In 1Q24, Microsoft reported operating margin of 48% compared with 43% in 1Q23. This was the highest over the last decade despite AI investments. The margin improvement was mainly due to top-line upside and continued focus on operational discipline (headcount down 7% YoY).

 

The Negatives

- Nil.

Microsoft Corp – Stabilizing cloud spending

 

 

The Positives

+ Azure continued to be a bright spot. In 4Q23, Azure cloud revenue grew by 27% YoY on a constant currency basis, at the high end of management’s guidance range, with about a 1 percentage point benefit from AI services. Growth continues to be fueled by corporate cloud-computing demand as enterprises look to lower OPEX and digitize their operations. Management highlighted that Azure OpenAI service now has 11,000 customers (IKEA and Volvo Group) compared with 4,500 in mid-May indicating early traction for its next-generation AI services.

 

+ Strength in Office 365 commercial revenue. Office 365 commercial revenue (under productivity and business processes) grew 17% YoY in constant currency driven by subscriber growth and ongoing ARPU increases as customers upgrade to the E5 license for its advanced security and analytics functionality. Microsoft reported paid Office 365 commercial user growth of 11% YoY again led by small-to-medium business and frontline worker offerings. While it is early days, we believe the adoption of Office 365 Copiplot AI tools can lead to an uplift in revenue (US$30 per user per month) and should enable Microsoft to maintain double-digit Office 365 growth rates.

 

The Negatives

- Deteriorating PC market hurt Windows and Devices. In 4Q23, more personal computing revenue fell by 4% YoY to US$13.9bn mainly due to Windows and Devices businesses. Windows OEM revenue, which includes the sales of Windows software to PC makers, declined by 12% YoY. Additionally, Devices revenue, including Microsoft Surface tablets and computers, HoloLens, and PC accessories, fell by 18% YoY. This is mainly due to weakening consumer demand for PCs and macro economic uncertainty.

Microsoft Corp – Azure remains the primary growth engine

 

 

The Positives

+ Azure remains the primary growth driver. In 3Q23, Azure cloud revenue grew by 31% YoY on a constant currency basis, in line with the company’s guidance. Growth continues to be driven by rising cloud adoption as enterprises look to lower operating expenses and digitize their operations. Management highlighted that Azure OpenAI Service customers spiked by 10x QoQ to more than 2,500 (Coursera, Grammarly, and Mercedes-Benz) indicating early traction for its next generation AI services.

 

+ Demand for Office 365 remains strong. Office 365 commercial revenue (under productivity and business processes) grew 18% YoY in constant currency driven by strong renewal trends and continued E5 momentum. Microsoft reported paid Office 365 commercial user growth of 11% YoY to 382mn led by small-to-medium business and frontline worker offerings. Management also highlighted that Teams surpassed 300mn monthly active users (vs. 280mn in 2Q23) with nearly 60% of Teams customers purchasing Teams Phone, Rooms or Premium.

 

The Negatives

- Deteriorating PC consumer market hurt Windows OEM revenue. Windows OEM revenue, which includes the sales of Windows software to PC makers, declined by 28% YoY. This is mainly due to weakening consumer demand for PCs, high inventory levels and macro economic uncertainty.

 

 

Microsoft Corp – Azure growth remains resilient

 

The Positives

+ Azure cloud unit remains resilient. In 2Q23, cloud remained Microsoft’s fastest growing segment with Azure revenue growth of 38% YoY in constant currency slightly above the company’s guidance of 37%. Growth continues to be driven by increasing cloud adoption and cybersecurity solutions, as companies look to reduce IT costs and digitalize.

 

+ Continued momentum in Office 365. Office 365 commercial revenue (under productivity and business processes) grew 18% YoY in constant currency driven by solid renewal trends and average revenue per user growth as customers upgrade to the E5 license for its advanced security, voice, and analytics functionality. Additionally, Microsoft reported paid subscriber growth of 12% YoY led by small and medium business and frontline worker offerings.

 

The Negatives

- Deteriorating PC market. Microsoft posted revenue of US$52.7bn for the quarter, equating to a 2% YoY increase, its slowest revenue growth since 2016. Revenue was hurt by a 5% FX headwind and soft PC environment. In 2Q23, Windows OEM revenue fell by 39% YoY driven by sharp drop in demand for PCs. Microsoft earns this revenue when PC manufacturers put windows on their devices.

Microsoft Corp – Azure drives growth despite currency headwinds

 

 

The Positives

+ Continued momentum in cloud business Azure. In 1Q23, Azure and other cloud services revenue grew 42% YoY in constant currency slightly below the company’s guidance of 43%.  The growth was mainly due to strong renewal execution and surge in the number of large and long-term Azure contracts driven by continued demand for cloud computing services.

 

+ Demand for Office 365 remains strong. Office 365 commercial revenue grew 17% YoY in constant currency driven by paid user growth of 14% YoY. The subscriber growth was mainly due to strong momentum in small and medium businesses and frontline worker offerings. Additionally, average revenue per user (ARPU) continued to increase due to the strong adoption of the E5 license. Upsell to this higher tier was largely due to robust demand for advanced security and Teams voice capabilities in Office 365.

 

The Negatives

- Slowdown in the PC market hurt Windows.  Windows OEM revenue, which includes the sales of Windows software to PC makers, declined by 15% YoY. This is mainly due to a slump in the sales of PCs and deteriorating demand as the spike in inflation forced customers to pull back on spending.

Microsoft Corp – Azure deals supporting growth

 

 

The Positives

+ Demand for Azure remains strong. In 4Q22, Azure and other cloud services revenue grew 46% YoY in constant currency vs 45% in 4Q21. Growth came from a record number of contracts worth more than US$100mn and US$1bn as customers made larger and longer-term Azure commitments. The strength in Azure and the continued shift to the cloud offerings helped drive solid growth in the Intelligent Cloud segment revenue, which grew 20% YoY to US$20.9bn in 4Q22.

 

+ Office 365 is another solid growth area. Office commercial products and cloud services revenue increased 9% YoY, driven by strong Office 365 commercial growth of 15% YoY (19% YoY in constant currency), which continues to be a key driver of success for the Productivity and Business Processes segment. Microsoft reported Office 365 Commercial user growth of 14% YoY, led by ongoing momentum in small and medium businesses, frontline worker offerings and expansion of average revenue per user (ARPU) due to strong adoption of E5 license. Dynamics 365 revenue grew 31% YoY while LinkedIn revenue grew 26% YoY.

 

+ Strong demand for cybersecurity drives E5 momentum. In 4Q22, the number of E5 users increased by 60% YoY and now accounts for 12% of the Office 365 commercial installed base. The upgrade to this higher-end tier was because of the robust demand for advanced security capabilities amid rising cybersecurity attacks.

 

 

The Negatives

- FX headwinds impacting revenue growth. Microsoft’s total revenue growth of 12% YoY in 4Q22 was the slowest since 2020. In 4Q22, the unfavorable foreign exchange rate movement negatively impacted revenue by US$595mn (or 4% of 4Q22 PATMI) and EPS by US$0.04 (or 2%). The FX impact was guided to decrease revenue growth in 1Q23 by 5%, while lowering the total cost of goods sold and operating expenses growth by 3%.

 

- Russia/Ukraine war and production shutdowns in China. With the ongoing Russia/Ukraine war, Microsoft has significantly reduced its business operations in Russia. As a result, the company’s operating expenses in 4Q22 increased by US$126mn related to bad debt expenses and asset impairments. Microsoft also witnessed a US$300mn in negative impact to Windows OEM revenue due to production shutdowns in China and slowing sales of PCs.

 

Outlook

For FY23e, Microsoft expects double-digit revenue and operating income growth in both USD and constant currency despite a worsening macroeconomic environment. Operating margins are estimated to be roughly flat as the benefit from extending the depreciable useful life for cloud infrastructure will be offset by FX headwinds. In 1Q23, Azure revenue is expected to be sequentially lower by just 3% on a constant currency basis, driven by continued strength in consumption of cloud computing services. Reopening of the economy will continue to drive user growth for Office 365 Commercial. We expect Microsoft to manage costs efficiently and invest aggressively to grow the business.

Microsoft Corp – Another strong quarter

 

Results at a glance

Source: Company, PSR. *Note – Azure revenue amount is not disclosed.

 

The Positives

+ All segments beat revenue estimates. In Productivity and Business Processes, commercial Office 365 and LinkedIn performed better-than-expected. Paid Office 365 Commercial users grew 16% to 345mn, exceeding our FY22e end target of 341mn, due to demand from small and medium business and frontline worker offerings. More Personal Computing benefited from continued strength for Microsoft 365 and commercial PCs, as well as a surge in search advertising on LinkedIn, up 33%, from a sharp demand uptick that started three quarters ago as the economy reopened amid a tight labour market. In Intelligent Cloud, Azure grew 49% YoY vs estimates of 47%, with continued consumption of cloud services.

 

+ Another quarter of margin beats. 3Q22 operating margins from Productivity and Business Processes, Intelligent Cloud and More Personal Computing were 46%, 44% and 34%, all higher than estimates of 44%, 40% and 33% respectively. ARPU was higher from continued momentum for Microsoft’s higher-end E5 licenses. Azure cloud services margins continued to improve. The faster growing higher margin LinkedIn services that reached a record high of 13% of total revenue this quarter also helped to boost margins.

The Negatives

- Revenue impact from stronger USD. FX decreased revenue growth by 3%, 1% more than expected. The stronger USD is guided to decrease revenue by 2% in 4Q22 while decreasing COGS and operating expenses by 1%, a net negative to operating margins.

 

Outlook

4Q22 was guided to be another strong quarter. Reopening of the economy will drive Office Commercial user growth from small and medium sized businesses, while cybersecurity needs will drive ARPU growth through upgrades to premium E5 licenses. Azure will continue to benefit from businesses’ shift to the cloud. MSFT stated that large (>US$100mn) long-term contracts for Azure saw better-than-expected growth even against a very strong prior-year comparable. Customers are not looking at cutting IT budgets despite slowing economic growth.

 

Maintain BUY and unchanged TP of US$410.00

Our valuation remains unchanged based on DCF with a WACC of 6.2% and terminal growth of 4.0%. Our FY22e PATMI is raised by 3.5% on stronger revenue guidance and a lower tax rate. Microsoft is at the forefront of digitalisation, benefiting from secular growth in cloud computing, cybersecurity and artificial intelligence. Microsoft’s productivity software is also crucial and the most economically viable solution amid the tight US labour market.

Microsoft Corp – Firing on all cylinders

 

 

The Positives

+ Azure growth exceeded expectations. Azure and other cloud services revenue grew 46% YoY vs the consensus growth forecast for 2Q22 of 44% and our FY22e forecast of 41%. The growth was due to continued strong demand for consumption-based cloud computing services. Microsoft now has six industry specific cloud solutions, up from one last year. These solutions include helping customers cope with supply chain constraints and the tight labor market. Cloud adoption has been strong across every sector.

 

+ Commercial bookings an overwhelming beat. Commercial bookings (customer spending commitments) were up 37% YoY vs consensus estimates of 11%. Growth came from an increase in the number of larger, long-term Azure contracts and strong execution across the sales force. Historically, commercial bookings have been a leading indicator of revenue growth next quarter for Microsoft’s Commercial Office segment (Figure 1).

 

+ Margin expansion across the board. All segments expanded operating margins in 2Q22. The productivity and business processes margin was 48%, up from 46% YoY, driven by higher average revenue per user (ARPU) from demand for premium licenses offering advanced cybersecurity, compliance and voice services. The intelligent cloud margin was 45%, up from 44% YoY, driven by improvements across cloud services. And the more personal computing margin was 36%, up from 34% YoY, driven by growth in the higher margin Windows and search advertising segments. Operating margins are on track to beat our FY22e forecast of 41%.

The Negatives

- Slight headwinds from stronger USD. Revenue growth impact from the stronger USD was 1% higher than expected. The FX impact was guided to decrease revenue growth in 3Q22 by 2%, while lowering the total cost of goods sold and operating expenses growth by 1%.

Get access to all the latest market news, reports, technical analysis
by signing up for a free account today!