Despite, at the grand old age of 48, being something of an elder statesman in the tech sector, Microsoft is once again demonstrating its ability to reinvent itself to maintain growth. Despite a slide from all time share price highs set in late 2021, Microsoft’s valuation declined by much less than most growth tech companies during the 2022 bear market, though it still saw its market capitalisation drop by 29%.
2023 has been a much more positive year for Microsoft, with the share price up almost 23% after an 8% surge following the release of its better-than-expected results for the first three months of 2023.
While most of the buzz around Microsoft this year has been focused on its ever-closer partnership with ChatGPT-creator OpenAI it is yet to feed through into revenues in any meaningful way, regardless of the future impact of AI as a growth catalyst.
But the company’s cloud computing business, particularly the Azure public cloud platform, continues to show strong growth and sales of its cloud-based Office365 productivity suite, now sold through a SaaS model that brings in recurring revenue, have kept growth healthy. Investors will be reassured by that against the backdrop of a tough economic conditions and efforts by companies to reign in spending.
The questions for investors now are how many more years of double-digit growth can cloud computing be expect to deliver? And how much value could a new market cycle of AI products and integration into existing products deliver?
Microsoft’s 2023 Q1 revenues beat expectations
But while AI is expected to be the major growth driver of Microsoft and its big tech peers over the next ten years or more, there are also plenty of reasons for investors to feel confident the here and now could deliver investment returns in the near term.
Microsoft yesterday posted expectations-beating results for the first quarter of 2023 with growth powered by revenue growth for its cloud computing division and Office 365, the cloud-based evolution of the Office productivity suite that includes Word, Excel and PowerPoint.
Across all business units, the tech giant’s revenue for the first three months of the year came in 7% higher than income generated over the same period a year earlier. That’s particularly impressive in the context of the tough 2022 macroeconomic environment not hitting results until the second quarter, with the first a strong benchmark to better. It also marks a new acceleration in growth after Q4 2022 delivered 2% y-o-y growth.
The $52.9 billion revenue brought in over the quarter was ahead of the $51 billion analysts had predicted with net income of $18.3 billion, up 9% on the previous year, also a notable improvement on the $16.6 billion expected.
The biggest catalyst for those positive earnings was Microsoft’s Azure public cloud platform. The cloud computing unit, the bulk of which’s revenues are generated by Azure, saw y-o-y growth of 16% to $22.1 billion. Azure revenue, which isn’t separately listed, was up 27%. That did, however, represent a deceleration from the 31% growth of the previous quarter as businesses look to either reign in cloud spend or pause major new cloud projects due to the rocky economic backdrop.
The other big plus was the 11% growth in Office 365 revenues to $17.5 billion, also an improvement on the previous quarter’s 7% growth from the cloud-based productivity software suite.
While Microsoft is keen to stress revenues during the past quarter have little to do with its high-profile embrace of generative AI through its partnership with ChatGPT creator OpenAI, it has begun to release previews of IA integration into Office products. However, the uptick in sales could be an early indication of customer interest in the prospect of AI-powered new functionalities.
One negative for Microsoft was declining revenue being generated by its Windows operating system, down 9% thanks to sluggish PC sales. PC manufacturers pay Microsoft a license fee to have Windows installed on their devices.
How much growth might Microsoft investors expect from the AI product cycle and cloud?
The revenue potential of AI, and when it will start to feed through to the bottom line in a meaningful way, is still a big unknown for investors, even if it looks likely to be the big opportunity of the next decade and beyond. Microsoft’s share price will not be significantly impacted until the commercial potential of AI starts to be felt in revenue growth.
There are also still doubts about just how competitive Microsoft will be in the AI race against its big tech peers, particularly Alphabet, which has invested tens of billions of dollars into its own AI R&D. While Microsoft may appear to have stolen a march on its rival by investing in and partnering with OpenAI, the reality is a major factor in that was a lack of inhouse investment in the space.
Google may have rushed to launch its own Bard generative AI assistant ahead of schedule in response to Microsoft integrating ChatGPT into its Bing search engine, whose international market share is a tiny (3% to Google’s 93%). But few doubt that Google and its holding Alphabet have its own impressive pipeline of intellectual property and products in the AI space.
There is evidence investor excitement about the potential value of the market for AI tools is already supporting Microsoft’s valuation, even if it’s not yet clear how quickly the company might make money from them. And how competitive it will end up being as an AI-powered tech company, despite the OpenAI tie-up.
But it will take evidence of a big AI impact on the company’s bottom line, or the clear prospect of such, before there is a real influence on Microsoft’s share price. Investors should still view Microsoft’s AI strategy with a “show me what you’ve got” attitude.
Cloud growth is, however, much more of a banker. Consulting firm Gartner estimates that companies will dedicate over half of their IT spending on cloud technology by 2025, and that chunk could be even higher if AI-powered products really take off over the next couple of years.
Azure may trail Amazon’s AWS as a public cloud platform but it will stand to take in a healthy chunk of that spend, especially as ChatGPT, whose API many of those products will rely on, uses Azure’s cloud platform. As such, investors are watching Azure’s performance closely in the belief the cloud business will dictate the company’s share price over the next 2-3 years.
Activision Blizzard acquisition in trouble after UK regulator blocks $69 billion deal
Microsoft received a setback today when the UK’s Competition and Markets Authority announced its opposition to the $68.7 billion deal to acquire Call of Duty maker Activision Blizzard. The regulator cited concerns the deal would reduce competition in the cloud gaming sector. Microsoft and Activision have predictably criticised the decision and said they will appeal.
Microsoft looks fair value today but could still hold lots of long term growth potential
For now, Microsoft’s exposure to AI through its investment in and partnership with OpenAI is most important in its role of giving investors confidence the company is on the front foot again and well positioned in what is expected to be a big new market.
Developing AI products commercially as a business unit will require far more investment than it will deliver revenues for years to come with more server infrastructure necessary and R&D costs. But as long as investors are confident AI can pick up the growth mantle from cloud several years from now, it will help underpin the company’s valuation and may even drive growth as commercial potential becomes clearer.
Microsoft doesn’t look especially cheap at its current valuation but investors may be willing to bet on its AI and cloud future, delivering returns in both the nearer and longer term.
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