• 1H22 revenue was in line at 50% of our FY22e forecasts, while PATMI exceeded expectations at 58% of FY22e.
• Azure revenue growth and commercial bookings exceeded expectations on continued demand for cloud computing.
• Operating margins elevated in every segment, driven by demand for premium licenses, improvements in cloud services and high-margin services.
• Maintain BUY with a higher target price of US$410.00 as we raise our FY22e PATMI forecast by 4%. Valuations based on DCF with a WACC of 6.2% and terminal growth of 4.0%. We expect another strong quarter in 3Q22 from continued strength in all segments despite slight headwinds from a stronger USD.

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%.