Category: Software

Microsoft Q4FY23 Pre-ER: Looking to build AI momentum into FY24

Posted on by io-fund

We recently wrote about Microsoft’s $100B revenue opportunity in AI and the potential valuation impact of its strategic AI initiatives that go beyond traditional valuation metrics. One approach treated the opportunity as a separate business unit aka Microsoft AI. Using conservative margin assumptions under this approach, we estimated that MSFT AI could earn $4-5 in eps and our bull case price of MSFT + MSFT AI is about $485 (+40%).

As you know, we are incredibly bullish on AI and these are starting points, not ending points. Specifically for Microsoft, we stated that it’s enterprise customer base would propel the company forward as an AI leader because enterprises are the perfect customer for AI. This is because enterprises can drive down costs and increase productivity for immediate ROI whereas consumers may be slower to adopt AI and/or see how it benefits them directly. The ability to directly monetize enterprise customers with AI features faster than peers is materializing with the $30/month CoPilot 365 plan.

MSFT is just beginning to incorporate AI into its core offerings – starting with Microsoft Bing Chat enterprise and Microsoft Co-Pilot 365 – which by its own estimates AI will only contribute 1% to its Azure division in q4. For example, based on an analysis done by Macquarie bank, AI could add $14B to sales in its first full year. 

We anticipate that MSFT will build upon its momentum from Q3 into Q4FY23. Meanwhile, 1hFY24 comps will also be supportive. MSFT’S commentary on the AI potential across its businesses in FY24 will be a clear, key focus. The upcoming quarters will be important to follow the growth and stability in Azure, Productivity and Intelligent Cloud businesses, as well, while looking for signs of the bottom in the Personal Computing division.

Fundamentally, we will monitor the impact on revenues and over time the margin impact on these units.

Here are the Q4 estimates going into earnings announcement on 7/25 (amc).

EPS

  • Q4FY23 consensus earnings of $2.54
  • Q1FY24 consensus of $2.60

Group Sales

  • Q4FY23 MSFT midpoint guidance of $55.35B (+7 y/y) vs Consensus of $55.42B
  • Q1FY24 consensus of $54.9 – we will want commentary on FY2024 in the call, not sure if CFO will provide as recently MSFT has pulled full year guidance given uncertainty in PCs

Microsoft sales guidance by division

  • Azure & other cloud – +26-27% y/y in constant currency, includes about 1% from AI services
  • Productivity & Business Processes – $17.8B to $18.28B, +8.7 y/y at the midpoint. CC guidance is 10% to 12% 
  • Intelligent Cloud – $23.6B to $23.9B up 13.6% y/y at the midpoint, CC guidance is 15-16%
  • Personal Computing – $13.35B to 13.75B, (-5.6%) y/y at midpoint

Margins

  • Q4FY23 MSFT gross margin of guidance of 69.5% vs Q323 of 69.5% actual vs Q223 of 67% actual
  • Q4FY23 MSFT operating margin of guidance of 42.1% vs Q323 of 42.3% actual vs Q223 of 41% actual

Cash flow + Cash

  • Q3FY23 operating and free cash flow was $24.5B and $17.8B for a margin of 46% and 34%, respectively
  • Q3FY23 cash stood at $104B and $48B in debt

Here are the things we’ll be looking for:

  • Microsoft Bing Chat and Microsoft Co-Pilot 365 – further insights into AI products, how it expects to impact sales, how it may evolve and the “domino” effect it may have on its other businesses
  • Big Tech has prioritized higher ROI capex (i.e., AI infrastructure) in 2023 calendar year. Analysts may ask CFO about FY2024 capex.
  • FY24 and Q124 guidance – MSFT will likely provide qualitative 2024 FY and financial Q1FY24 guidance. Meanwhile consensus is estimating a decline in sales in q4/q1. Anything better will be viewed positively. Consensus is forecasting FY2024 sales and eps growth 11.8% and 14.2%, respectively. Neither of which appear to be demanding given the underlying secular demand drivers.
  • FY2024 profitability outlook – In FY2023, MSFT pulled several levers to manage its margins from corporate restructurings to accounting change to equipment useful life. We will look for the key drivers that will drive FY2024 margins.  
  • Azure and cloud competitive dynamics and growth – is MSFT taking market share in its Azure cloud related businesses and what is the growth outlook. Plus, comments on the overall corporate IT spending environment.
  • Current PC environment, the channel inventory situation and if it’s closer to the bottom. Macro and how it’s impacting its consumer related businesses
  • Update on Activision merger – recently Microsoft and Activision Blizzard jointly agreed to extend the merger agreement deadline from July 18, 2023, to October 18, 2023, to allow for additional time to resolve remaining regulatory concerns.

Here’s what analysts are saying

Stifel raised the firm's price target on Microsoft to $380 from $320 and keeps a Buy rating on the shares. The firm believes Azure should post "solid upside" to management's 26%-27% year-over-year constant currency growth guidance given strong enterprise checks, management's commentary that implied optimization activity should begin to abate as customers lap initial efforts and the firm's expectation of greater than expected AI contribution. The firm expects new Cloud project go-live growth to stabilize as customer's return to reinvesting into cloud migrations

Citi raised the firm's price target on Microsoft to $425 from $340 and keeps a Buy rating on the shares. The analyst remains positive on the shares into the company's fiscal Q4 results. Citi's reseller survey shows improving target achievement levels and an expected acceleration in growth into fiscal 2024, the analyst tells investors in a research note. To reflect signs of improving channel partner inputs and generative artificial intelligence tailwinds, the firm raised estimates "more substantially" across Office 365 Commercial and Azure.

Mizuho analyst Gregg Moskowitz raised the firm's price target on Microsoft to $420 from $390 and keeps a Buy rating on the shares. The big news from day one of Microsoft Inspire came in the form of a $30 per user per month add-on for Microsoft 365 Copilot, the analyst tells investors in a research note. The firm estimates the cumulative incremental revenue from Microsoft 365 Copilot by the end of fiscal 2025 could exceed $9B using a 20% attach rate, and approach $19B using a 40% attach rate. It remains confident that Microsoft's growth opportunities over the medium term and beyond are "greater than many realize."

JPMorgan raised the firm's price target on Microsoft to $385 from $350 and keeps an Overweight rating on the shares. The analyst left the company's Inspire conference "incrementally positive" on its category leadership in artificial intelligence. The announced M365 Copilot pricing of $30 per user per month is an "upside shocker" versus investor expectations closer to $10, the analyst tells investors in a research note. The price point aligns with the perspective that Copilots are far exceeding expectations in the private preview stage

BofA analyst Brad Sills raised the firm's price target on Microsoft to $405 from $340 and keeps a Buy rating on the shares. BofA expects Microsoft to report "healthy 1% upside" to the firm's Q4 revenue estimate of $55.45B, based on Azure and O365 strength. The firm also expects upside to its Azure estimate of 27% year-over-year constant currency growth due to better AI/ML workloads and baseline migration strength, the analyst tells investors in an earnings preview note. BofA forecasts double digit constant currency FY24 revenue growth guidance, assuming "conservative" low 20s percentage Azure growth, low/mid-teens O365 growth and Windows OEM growth of 2%.

Bernstein analyst Mark Moerdler notes that Microsoft announced Bing Chat Enterprise and Microsoft 365 Copilot pricing earlier, which is higher than the firm expected, at $30 per user per month for Microsoft 365 E3, E5, Business Standard, and Business Premium editions. This is a price uplift of 53% to 240%, to list price of these SKUs, depending on what Microsoft 365 edition being used. The price lift is similar to that of Microsoft GitHub Copilot. It is important to note that this announcement is only for Microsoft 365 and not Office 365, Bernstein notes. While Microsoft offers Office 365, their go-to-market focus has been in driving the Microsoft 365 bundle, Bernstein has an Outperform rating and a price target of $380.

The I/O Fund Analyst Team contributed to this analysis

Recommended Readings:

I/O Fund’s Overview of 7 Cloud Stocks for Q3 Earnings – December Edition

Posted on by io-fund

I/O Fund is covering the preview for the second part of earnings for cloud stocks. It includes seven of the leading cloud security, productivity tools and data analytics companies.

We covered the first round of cloud earnings at the beginning of November.

We now cover:

  • Zscaler Inc
  • CrowdStrike Holdings Inc
  • Elastic N.V
  • Snowflake Inc
  • Okta Inc
  • DocuSign Inc
  • Asana Inc

These earnings previews help our readers keep track of changes in trends and where to focus for new opportunities. It also helps to hear what analysts are saying about key companies prior to earnings reports.

We noticed that cloud companies with solid stock performance on the run-up to the results beat estimates. For example, Cloudflare stock rose 67% a month before our coverage and the company had a blowout result. We identified in this analysis that the company is adding numerous customers and, also, the trend continued in its third-quarter results.

To better understand recent valuations across cloud stocks and how the sector is positioned, please refer to our analyst Bradley Cipriano’s analysis, “I/O Fund Q3 2021 Cloud Stock Earnings Preview – December Edition”.

 

Zscaler – Earnings on November 30

Source: YCharts and Earnings Reports

Zscaler Inc has recently rescheduled the release of its results a day earlier as peer companies are releasing on December 1st. The consensus revenue estimates suggest a 49% YoY growth and are slightly higher than the management’s revenue guidance of $210M to $212M. Zscaler is up around 140% in the past year and has been outperforming cybersecurity peers.

Source: YCharts

Mizuho analyst Gregg Moskowitz raised the firm's price target to $385 from $320 and has a buy rating on the company. The analyst says software valuations have "continued their ascent in recent weeks" and that he's raising price targets to reflect recent appreciation in comp multiples.

BTIG analyst Gray Powell has a buy rating and raised the firm's price target to $401 from $324. The analyst states that his discussion with an industry expert and his checks over the last few weeks indicate a positive spending environment across the majority of categories in the space. Powell adds that the expert described the Zscaler business as one that continues to accelerate, following "strong" demand trends observed for the company in October.

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Daiwa analyst Stephen Bersey initiated coverage of Zscaler with a neutral rating and a $266 price target. The analyst says the stock's trading multiple is near a level that he believes is appropriate. While Zscaler's recent sales growth results have been well above many of its peers, a 28x sales multiple more than accounts for its strong top-line growth and earnings potential.

Please note, I/O Fund is objectively reporting what the Street is saying. We covered Zscaler previously below:

Tech Growth Earnings Review for Q3 2020 – Part 3

CrowdStrike – Earnings on December 1

Source: YCharts and Earnings Reports

CrowdStrike’s revenue accelerated 70% in the 2Q to $337.7M and subscription revenue increased by 71% YoY to $315.8M. It added a net 1,660 subscription customers, raising the total to 13,080 subscription customers. Recently, it announced new security products to expand its reach in extended detection technology (XDR).

DA Davidson analyst Rudy Kessinger initiated coverage of CrowdStrike with a buy rating and a $320 price target. The analyst is positive on the company's "superior" cloud-native technology that has significant network effects driving sustainable competitive advantages, along with its large and expanding total addressable market. Kessinger further cites CrowdStrike's multiple drivers to sustain high rates of growth and its "significant operating margin expansion" that is likely over the next several years.

Morgan Stanley analyst Hamza Fodderwala has undertaken coverage on the stock with an underweight rating and a price target of $247. He said in a research note that CrowdStrike has benefitted from the shift toward digitalization and remote work over the past two years and gained a leading position in the area of what’s called endpoint detection and response (EDR) security.

However, Fodderwala said that checks within the security industry "indicate CrowdStrike's early leadership position is now increasingly challenged by more competitive next-gen EDR alternatives." Fodderwala said that competitors have come in and undercut CrowdStrike's prices by at least 15% to 20%, and that "this competitive dynamic will make sustaining [CrowdStrike's] current pace of share gains more difficult" through 2022 as working from home becomes commonplace.

Read our previous analyses below:

Nasdaq100 Levels to Watch for the Next Leg Higher

Tech Growth Earnings Review for Q3 2020 – Part 3

Momentum is on CrowdStrike’s Side: Will it Last?

Elastic – Earnings on December 1

Source: YCharts and Earnings Reports

Elastic N.V’s revenue grew by 50% in the last quarter and Elastic Cloud revenues increased 89% YoY to $61.5M (accounts for about 32% of total revenue). The company had over 16,000 subscription customers at the end of Q1. However, growth is expected to slow down in the next quarter. Management’s revenue guidance is between $193M to $195M, representing a YoY growth of 34% at the mid-point.

Source: Investor Presentation

Barclays analyst Raimo Lenschow raised the firm's price target on Elastic to $200 from $185 and kept an overweight rating on shares. In a research note, Lenschow informs investors that over the next few months, investors will move to 2023, their new base year for valuations. For software, "with its high growth rates, this move is important as valuation levels often see a meaningful step down," says the analyst.

Oppenheimer analyst Ittai Kidron has an overweight rating and a price target of $185. The analyst notes Elastic reported a "strong" Q1 well ahead of consensus, reflecting broad-based demand across search, observability, and security; continued SaaS momentum; strong customer adds; and steady expansion metrics.

Read our previous analysis on the stock here: Tech Growth Earnings Review for Q3 2020 – Part 3

 

Snowflake  – Earnings on December 1

Source: YCharts and Earnings Reports

The company’s revenue growth has been solid. During 2Q, total revenue accelerated 104% YoY and product revenue accelerated by 103% YoY to $255M. The remaining performance obligation (RPO) grew to $1.5B at the end of the second quarter. It also reported adjusted free cash flow for the third consecutive quarter.

For the next quarter, revenue is expected to decelerate slightly and management has given product revenue guidance in the range of $280M to $285M.

Source: Investor Presentation

Credit Suisse analyst Phil Winslow initiated coverage of Snowflake with an outperform rating and a price target of $455. Winslow views Snowflake as a true pioneer in cloud-native data analytics and believes the company will play an increasingly important role across the entire data value chain– telling investors, in a research note, that Snowflake is helping drive strong new customer acquisition, robust customer expansion, and attractive unit economics that can be sustained longer than the market appreciates.

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Rosenblatt analyst Blair Abernethy downgraded the stock from a buy rating to a neutral rating. At the same time, he raised the price target to $370 from $300 and believes most near-term gains are already priced into the stock.

Read our previous analyses:

Snowflake: IPO In-depth Analysis

Podcast: My favorite picks for 2021, Zoom Video, and IPOs/SPACs

Analyzing the IPO Glut of 2020: Snowflake, AirBnB, DoorDash and Roblox

Okta – Earnings on December 1

Source: YCharts and Earnings Reports

The company’s revenue in the 2Q grew by 57% YoY to $315.5M. On a standalone basis, Okta revenue grew by 39% YoY and it was the first quarter that included Auth0 revenues. The company’s TTM Net Retention rate has been quite stable and, in the most recent quarter, it came at 124%.

Source: Investor Presentation

Morgan Stanley analyst Hamza Fodderwala has updated the company to an overweight rating with a price target of $315. In his words, “After slower topline over the past year, an improving demand environment and more buy-in with developers should drive stronger growth and upside in estimates going forward.”

DA Davidson analyst Rudy Kessinger initiated coverage of Okta with a Buy rating and $315 price target. The analyst says Okta is a "best-of-breed" cloud workforce identity and access management provider that is still in the early innings" of growth. He sees sustainable 35%-plus growth and "compelling" margin expansion through fiscal 2026 for the company.

Read our past analyses on the company:

Podcast with Motley Fool: I’m Bullish on These Trends for 2021

Okta Earnings: More to Squeeze From Valuation?

DocuSign – Earnings on December 2

Source: YCharts and Earnings Reports

DocuSign’s revenue in the 2Q increased by 50% YoY to $511.8M. The international business grew by 71% YoY to $114M. The company’s Net Dollar Retention rates have improved in the past few quarters, and, for the most recent quarter, it was 124%. The management anticipates revenue of $526M to $532M in the 3Q.

Source: Investor Presentation

Needham analyst Scott Berg raised the firm's price target on DocuSign to $340 from $275 and keeps a Buy rating on the shares. The company reported a "strong" Q2 with "typical" upside to revenue and profitability. He further adds that while DocuSign's sales metrics and growth decelerated sequentially, this was at a much slower rate than the Street was anticipating.

Asana – Earnings on December 2

Source: YCharts and Earnings Reports

This company’s revenue growth in the 2Q was strong as it grew 72% YoY and 11% QoQ. It added 7,000 net paying customers, exceeding 107,000 in total. Management has raised full-year revenue guidance to $357M-$359M, representing a YoY growth of 57% to 58%, up from previous guidance of $336M to $340M.

Piper Sandler analyst Brent Bracelin raised the firm's price target on Asana to $140 from $85 and kept an overweight rating on the shares. The analyst says multiple third-party data inputs across domain traffic, job postings, and application downloads give him an upward bias to street estimates of 59% growth for Q3 and 33% growth next year. While the stock's risk/reward is less favorable after the 345% year-to-date run, Asana remains a "compelling high margin and high growth model that is still in the nascent stages of adoption with fewer than 2 million paid users.”

Jefferies analyst Brent Thill downgraded Asana to Hold from Buy with a price target of $135, up from $115. The analyst cites valuation for the downgrade, with shares up 348% year-to-date. He continues to view Asana as a "differentiated solution for work management in a large and growing market" but says the valuation is full at current levels. Thill looks to get constructive at a "more reasonable valuation."

You can read our previous analysis here: Asana Setup (5/20/21) – up 85% in a month

I/O Fund is comprised of a team of analysts who share their research publicly as they build a portfolio of 30 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here. clicking here or sign up for our free newsletter here.

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.

I/O Fund Q3 2021 Cloud Stock Earnings Preview – December Edition

Posted on by io-fund

Tech earnings season is long and extends over six weeks. We are finally nearing the end of Q3 earnings season as the last round of cloud companies are expected to report in early December. The I/O Fund had previously highlighted Six Cloud Stocks to Watch During Q3 Earnings, all of which have since reported Q3 results.

One of the notable performers we highlighted was Bill.com, which reported an 11% topline beat during the quarter. I/O Fund analyst Bradley Cipriano discussed the company’s strong Q3 results in a short video presentation here.   

In the analysis that follows, we provide an update on the cloud category and review cloud stocks that have yet to report Q3 earnings. We also discuss key metrics that investors should be aware of heading into the final weeks of Q3 earnings season.

Cloud Stocks: Top 10 EV/FWD Revenue Multiples

Below is a table of cloud stocks that have yet to report Q3 results, ranked by their EV/FWD sales multiples. Snowflake has the richest multiple out of the 26 remaining cloud stocks set to report in the next few weeks. As we mentioned in our initial Q3 Cloud Earnings Overview, Snowflake is benefitting from increasing rates of data consumption, a trend that will likely continue into the future.

Somewhat cheaper than Snowflake but still sporting a premium multiple are Asana, Zscaler, and MongoDB. Asana most recently grew 72% YoY, an acceleration from the 61% and 57% YoY growth rate in Q2 and Q1, respectively. Zscaler sales grew over 55% for three consecutive quarters and sales are expected to grow 50% in the upcoming quarter. MongoDB has reported an acceleration in sales for three consecutive quarters, and the most recent 44% YoY growth was the fastest pace of growth since Q1 2020. These strong growth trends help illustrate why these firms have premium valuations.

Cloud Stocks: Top 10 Three-Month Forward YoY Growth Rates

Below is a chart of forward sales growth expectations.

Out of the remaining cloud stocks that must report Q3 earnings, Snowflake and Kingsoft are expected to grow the fastest. Snowflake is expected to grow sales 92% YoY as the company continues to benefit from rising rates of data consumption.

Chinese cloud infrastructure company, Kingsoft, is also expected to grow sales strongly in Q3 as they quickly scale their operations.

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Other noteworthy mentions are CrowdStrike, Okta, and Zscaler, all of which have exposure to cyber security, a sector that has seen outsized growth recently. These three cyber security firms are expected to grow sales ~50% YoY heading into Q3 earnings, highlighting the overall strength in the cyber security market.

Top 10 Weekly Share Price Movements

Below is a table of the weekly change in share price for our universe of cloud stocks (week ended 11/19). Zscaler is a notable stand out and increased 6% during the week. It is up 85% YTD. Out of the 26 cloud stocks that have yet to report Q3 earnings, Zscaler and Snowflake were the only stocks that advanced last week.

Top 10 Changes in Sales Growth Estimates – Last 90 Days

The table below ranks cloud companies that have yet to report Q3 earnings by their topline revisions over the last 90 days. An increase in topline revisions signals that the Street believes that the company will grow faster than initially believed.

Smartsheet (SMAR) has had the largest topline revision, as the company recently increased their Q3 sales guidance from 40% YoY growth to 46% YoY growth, citing a robust demand environment for its platform.

Zscaler also had its topline revisions increase 5% over the last 90 days, above other cyber security players such as CrowdStrike and Okta. This increase in expectations signals that Zscaler is likely expected to outperform its peers in the near term.

 

Update on Top 5 EV/Fwd Revenue Multiples:

Overall stats:

  • Overall Cloud forward median:    15x
  • Top 5 Cloud forward median:       69x
  • Overall Cloud forward average:  22x

OVERVIEW OF EV/FWD SALES:

As shown below, the median and average cloud EV/Fwd revenue multiple has trended up throughout the year. Around June, the average multiple had started to increase faster than the median, and this bifurcation accelerated during Q3 earnings.

The average is being driven higher by premium valued cloud stocks (shown above). Since cloud has increasingly proven to be a sector where the leader ‘wins most’, this bifurcating trend may very well continue into the future.  

 

TOP 5 HIGH-RANKING EV/FWD SALES:

In the chart below, we can more clearly see the large dispersion in cloud valuations, as the top 5 premium valued cloud stocks have had their EV/Fwd sales multiples rapidly expand through Q3 earnings. Investors likely continue to believe that cloud is a “winner gets most” market, where the market leader captures the majority of the addressable market. This dynamic helps explain why the top 5 valued cloud stocks have grown their multiples much faster than the median.

EV TO FWD SALES – Growth Buckets:

We can further dissect the changes in cloud valuations by breaking up the group into high growth (>30% growth), mid growth (>15% and <30%), and low growth (<15%). The below chart shows that higher growth cloud stocks receive a higher multiple from the Street. Furthermore, high growth stocks used to be valued more richly back in Q4 2020 but have since seen their valuations normalize to a lower multiple. If Q3 cloud earnings come in strong, then the market may push valuations back up to their historic highs.  

WHO DELIVERS SUPERIOR EV TO FWD SALES?

The below chart provides a more holistic view of the remaining cloud stocks that have yet to report Q3 results, sorted by their EV to Fwd revenue multiples.

As highlighted in the above tables, Snowflake (SNOW) has the highest valuation of the group and its multiple is more than 600% higher than the cloud median of 15x.

Growth Adjusted EV/Fwd Revenue (EV/Fwd Rev/Fwd Growth)

The last chart (below) is based on EV to FWD sales but also takes into account forward growth expectations.

By scaling valuation relative to forward growth, we can more clearly see which companies are cheapest, based on their expected growth rate. A low value in the chart below means that a company is cheap relative to growth.

For example, Snowflake can be considered cheaper than Asana once we consider its strong growth rate expected next quarter.

Kingsoft (KC) is evaluated as the cheapest; given its robust growth rate and low valuation, the company has very low margins, which warrants a cheaper valuation.

 

CLOUD OUTLOOK

Finally, the last table we will be discussing includes aggregate cloud operating metrics.

The below table shows that cloud is performing strongly as the median forward growth rate is above 20%, while gross margins are high at over 70%. The median cloud company is also FCF positive with a 3% FCF margin.

 

Strong growth and positive cashflows signal that the cloud category is healthy and performing well. I/O Fund expects this strength to progress going forward.

Find out which cloud stocks I/O Fund will be watching, heading into the final weeks of Q3 earnings, in analyst Royston Roche’s piece, “I/O Fund’s Q3 Earnings Preview of Cloud Stocks -December Edition.”

I/O Fund is comprised of a team of analysts who share their research publicly as they build a portfolio of 30 stocks. Our team has record results for a retail Fund and we also have four-digit gains on some of our free newsletter coverage. You can learn more about our premium service by clicking here or sign up for our free newsletter here. clicking here or sign up for our free newsletter here.

Disclaimer: This is not financial advice. Please consult with your financial advisor in regards to any stocks you buy.