• 1H23 revenue/PATMI was within expectation at 48%/46% of our FY23e forecasts. In 2Q23, total revenue grew just 2% YoY as it witnessed weakness in its PC software.
• Cloud momentum continuing with Azure revenue growth of 38% YoY in constant currency. Office 365 Commercial revenue grew 18% YoY due to subscriber growth of 12% YoY and higher average revenue per user as E5 momentum remained strong.
• PATMI fell by 12% YoY (7% YoY drop normalized) due to higher OPEX and tax rate. The company recorded a charge of US$1.2bn, including US$800mn related to the job cuts.
• We maintain a BUY recommendation with a lower DCF target price of US$298 (WACC 7.2%, g 4%), down from US$319. Our FY23e revenue/PATMI is lowered by 4% to account for PC market weakness and customers seeking to increase the efficiency of their cloud spending. Overall, Microsoft enjoys long-term tailwinds from digital transformation spending, shifting of workloads to the cloud, and cybersecurity upgrades.

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.