• 1Q23 revenue/PATMI was within expectation at 23% of our FY23e forecasts. Total revenue grew 11% YoY to US$50.1bn driven by a 20% YoY rise in cloud business. PATMI fell by 14% YoY (2% YoY growth normalised) as margins contracted due to investments in Azure as well as US$3.3bn tax benefit in 1Q22.
• Azure revenue grew 42% YoY in constant currency driven by increasing cloud adoption. Office 365 Commercial revenue grew 17% YoY due to subscriber growth of 14% YoY and higher average revenue per user due to strong adoption of E5 license.
• We maintain a BUY recommendation with a lower DCF target price of US$319 (WACC 7.2%, g 4%), down from US$332. Our FY23e revenue/PATMI is lowered by 2%/3% to account for forex headwinds and PC market weakness. Overall, we believe that Microsoft will be a long-term beneficiary of continued strong digital transformation spending, shifting of workloads to the cloud, and cybersecurity upgrades.

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.