• 4Q22 results were in line with expectations. FY22 revenue/PATMI was at 99% of our forecasts. Total revenue grew 12% YoY to US$51.9bn in 4Q22, mainly due to Productivity and Business Processes and Intelligent Cloud revenues. PATMI was only up 2% YoY as margins contracted due to investments in cloud engineering and FX headwinds (4% of 4Q22 PATMI).
• Azure revenue grew 46% YoY in constant currency in 4Q22 driven by continued demand for cloud computing. Office 365 Commercial revenue grew 19% YoY due to higher volumes and prices.
• We maintain a BUY recommendation with a lower DCF target price of US$332 (WACC 7.1%, g 4%), down from US$338. This is mainly because we reduced our FY23e revenue/PATMI by 3%/4% to account for headwinds from a stronger USD and slowing sales of PCs. Overall, we believe that Microsoft will be a long-term beneficiary of continued shift to the cloud, businesses reopening, cybersecurity upgrades, and price increases at renewals.

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.