We are eyeing a LTBH position for Microsoft. As many of you remember, we’ve owned Microsoft in the past following a spree of analysis published in 2018-2019.
In our latest Q2 webinar, I discussed why reducing cloud costs is a key trend for 2022 and beyond. Most investors on our site agree that cloud is a critical trend to have in a portfolio as it increases productivity and reduces costs. This is especially true for software-as-a-service whereas cloud infrastructure as-a-service does not always result in lower costs compared to on-premise servers.
The overall cost savings and/or overhead can often rely on the size of company, where it’s a no-brainer for startups to rent servers as they don’t have the budget to own servers and manage an IT department. However, we’ve pointed out in an analysis and on our webinar that companies of Dropbox, Asana or Datadog’s size are seeing a hit to their margins. If you add up the cloud infrastructure, platforms and software costs across a company, it can often become costly to manage and deploy a full cloud stack.
To put it simply, Sayta Nadella said in yesterday’s call: “More value for less price means you win.” In the same breath, he also said: “Most businesses are not looking to their IT budgets or to digital transformation for budget cuts.” These two statements echo my first point in the webinar which is that both are true: increase in cloud spending and wanting to lower costs. This is differentiated from budget cuts, such as headcount. Most importantly, our slides showed that despite Gartner’s forecast for 2020-2021 shifting by $100 billion to what became actual spend (or essentially a pull forward). Pull forward might not be the right term, however, as cloud growth is not slowing down as a result, instead it’s predicted to be a tick higher from 2019 to 2022, if we remove the anomalous 2020-2021.
Therefore, we wanted to emphasize that the trend towards reducing costs should not be confused as being prohibitive to the trend for cloud adoption, rather, it can offer investors an edge if they identify what companies serve both needs.
As you can see from our portfolio, we are best-of-breed investors and I do not believe Microsoft is a best-of-breed company, rather they aggregate cloud services to help drive down costs. This is especially attractive for the Fortune 500 whereas startups, SMBs and mid-sized enterprises are likely to seek out and manage a larger portfolio of cloud services from various vendors. We can easily evidence this by Microsoft’s Fortune 500 penetration with 95% using Azure, which was achieved through hybrid computing where Microsoft was first-to-market on serving a mix of on-premise, private and public clouds for their large enterprise customers. Secondly, as this analysis is about, Microsoft is undercutting other services on price to win the aggregate, long-term contract.
Microsoft is using the term Tier 1 workloads to not exclude those outside of the Fortune 500, and the company stated the following in terms of deal size: “The number of $100 million-plus Azure deals more than doubled year-over-year. “
As stated on the I/O Fund Wire, Azure growth of 46% is performing quite well given the tough comps it has overcome, and Microsoft’s best financial metric during this tech selloff is that commercial bookings increased 28% this quarter following 32% increase last quarter. I would look for Azure to remain elevated against AWS and Google Cloud for those two reasons – hybrid cloud leader which attracts large enterprises and its ability to reduce costs with its tech stack.
Despite overall revenue softening from 20% to 18%, Azure remained flat at 46%. This is quite remarkable considering Azure has overcome incredible growth over the past two years. Operating income was up 19% and EPS up 9%. The lower overall revenue guide is driven by gaming and Office 365, both expected to be lower by single digits. Azure growth is also guided to be sequentially lower yet Intelligent Cloud is a stronger-than-expected guide at $21.1 billion and $21.3 billion. This is what is meant by the analyst on the call when they stated: “
Starting in September, we began to position for Big Data, Analytics and ML. Microsoft has grown their Cosmos database (DB) transactions and data volume by 100% year-over-year for the third quarter in a row. Synapse data volume has also doubled. Monthly machine learning inference requests increased 86% year-over-year. Takeaway: Let’s hope this translates well for our larger holdings MDB and SNOW, and our placeholder on CFLT. This was also covered in the Q2 2022 webinar.
According to our research, cybersecurity is the top tech vertical for increased spending from 2021 to 2022. Microsoft is increasingly becoming a cybersecurity company, as well, with $15 billion in revenue and growing at a rate of 45%. Microsoft was careful to build a multi-cloud product and is the only Big 3 cloud vendor to be multi-cloud on security right now.
On a side note, not only does Datadog, SentinelOne and Cloudflare participate in cybersecurity here but they also reduce costs through standardization and/or eliminating object storage fees.
Catalysts
There are a few reasons Microsoft can continue to do well, in addition to its proven strategy to onboard large enterprises and lock them in by optimizing workloads for Azure and its broader suite of cloud platforms and services. The first reason is that I believe Microsoft will own the edge. The company is closely partnered with many telecoms and has the most data centers in the world. Another reason is that when more enterprises adopt AI/ML, whether it’s automation, super computers and/or other use cases for training and inference, it will a natural decision to use Microsoft if they’re already optimized for Azure. In other words, Tier 1/Fortune 500 are likely to be the largest customers for AI/ML. Power Automate was up 72% year-over-year, surpassing $2 billion in revenue, although not vendor agnostic like UiPath. Third, the company ranks with Nvidia and Unity for inroads to the Metaverse as it owns many gaming publishers now and is the most widely used VR headset (HoloLens). The company also has Teams to introduce Metaverse-like qualities to business meetings. It will be industrial that drives forward 3D worlds (not consumer) and Microsoft is auspiciously positioned.
These catalysts matter a little less when macro is so tough but worth mentioning as to why investors should look beyond Azure growth when it comes to Microsoft.