Cloud Software – I/O Fund

AI Driving Acceleration For Big 3 Cloud Stocks

Posted on February 13, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Forbes Forbes on Feb 8, 2024,07:01pm EST

Big Tech’s participation in the market’s push to all-time highs is becoming increasingly narrow, with Nvidia, Meta, Microsoft and Amazon serving as the primary contributors to 2024’s rally. Though Alphabet fell more than 7% on somewhat disappointing Google ad revenue, Alphabet’s Google Cloud, Microsoft’s Azure, and Amazon’s AWS shined as generative AI products drove an acceleration in cloud revenue growth in the recent quarter.

Source: Trading View

The Big Three’s cloud segments are crucial to business performance on both the top and bottom lines: Azure sits as Microsoft’s fastest growing segment (excluding Xbox’s more than 40 percentage point impact from Activision in Q2), AWS is driving a lion’s share of Amazon’s operating income, while Google Cloud is now generating more than 10% of revenue as Alphabet’s fastest growing segment while expanding its operating margin.

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Microsoft’s Azure

Azure witnessed the strongest AI contribution by far, as Microsoft works to extend its lead as the first major tech player to monetize enterprise and consumer AI subscriptions at scale. Azure also is powering a handful of the largest LLMs and AI assistants on the market, from OpenAI’s ChatGPT to Meta’s Llama and Llama 2 to Microsoft’s own Bing Copilot.

We highlighted in October in our free newsletter that AI would help drive a ‘noticeable acceleration’ for Microsoft’s revenue this year, and that’s exactly what we’re seeing: revenue growth accelerated from 8.3% YoY in fiscal Q4 2023 (calendar Q2) to 17.7% YoY in fiscal Q2 2024 (calendar Q4).

Azure growth was 30% in fiscal Q2, a 200 bp QoQ acceleration driven by strong demand for consumption-based services. Yet AI’s impact was quite notable: Microsoft said the 30% growth rate for Azure included “6 points from our AI services.”

Source: Microsoft

This 6 point contribution is impressive, given that AI services contributed 3 points to growth last quarter and 1 point in fiscal Q4 — a significant ramp considering the scale that this growth is attached to, with Azure’s revenue at a $74 billion run rate. This AI-related growth has helped Azure’s growth re-accelerate after seeing decelerating growth for five straight quarters.

Azure’s AI customer growth has also been rapid, and Microsoft is seeing an increase in larger commitments for Azure. Microsoft reported that Azure AI customers totaled more than 53,000 last quarter, with one-third of these new customers over the past twelve months. That implies customer growth rate of approximately 50% YoY, given that Microsoft added nearly 18,000 customers through 2023. More than half of the Fortune 500 are using Azure OpenAI Services, highlighting the strength of Microsoft’s AI offerings.

For Azure specifically, management said on the earnings call that “customers continue to choose Azure to simplify and accelerate their cloud migrations. Overall, we are seeing larger and more strategic Azure deals with an increase in the number of $1 billion-plus Azure commitments.” An increase in customer count and an increase in deal size are foundations for sustainable long-term growth and supportive of further acceleration in the coming quarters.

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Amazon’s AWS

Q4 was a busy quarter for Amazon as it rolled out many new features, capabilities and hardware designed to capture generative AI demand, with AWS showing a hint of accelerated growth. AWS finally accelerated in Q4 for the first time in 2 yearsQ4 for the first time in 2 years, with Amazon reporting 13.2% growth in Q4, up just over 1 point from Q3’s 12%. AWS is now quickly approaching a $100 billion annual run rate, delivering $24.2 billion in revenue in Q4 and $90.8 billion in revenue for 2023.

What’s more important is that AWS’ operating leverage has improved over the last two quarters, with operating income growing at 3x the rate of revenue in Q4.

Source: Amazon

AWS’ operating income increased 39% YoY on a constant currency basis in Q4, with operating margin increasing 530bp YoY to 29.6%. For the full year, AWS’ operating margin was 27.1%, down 140bp YoY as operating leverage decreased in the first half of the year as growth decelerated from the 20% range to the 12% range.

AWS remains Amazon’s primary generator of operating income (67% of Amazon’s total operating income in 2023), a trend that can strengthen with AI driving accelerated customer and revenue growth and decreased costs. CEO Andy Jassy explained that AWS “added more than $1.1 billion an incremental quarter-over-quarter revenue, which on an FX neutral basis is more than any other cloud provider as far as we can tell.”

AWS’ existing customers “are renewing larger commitments over longer periods and migrations are growing,” and “while cost optimization continued to attenuate larger new deals also accelerated.” That includes recent agreements with Nvidia to be the first CSP to deploy the GH200 Grace Hopper Superchips with multi-node NVLink technology, and with Salesforce to deepen AI and data integrations between the two.

Bedrock is already witnessing strong adoption, with management seeing “many thousands of customers using the service after just a few months” as AWS continues to add “new models from Anthropic, Cohere, Meta with Llama2, Stability AI and our own Amazon Titan family of LLMs.”

Although AWS’ quarterly growth rates look paltry compared to Azure’s 30% and Google Cloud in the high-20% range, it is still showing all the ingredients for a sustained AI-driven acceleration.

Google Cloud

Google Cloud revenue accelerated four points from 22% in Q3 to 26% in Q4, topping $9 billion for the first time, helped by an increasing contribution from AI. Q4’s $9.2 billion in revenue implies that Google Cloud is just crossing above a $36 billion annual run rate, less than half of Azure’s run rate and 60% below AWS’ $90 billion run rate.

Google Cloud’s operating margin in Q4 came in at 9% compared to 3% in the previous quarter and (0.2%) in Q4 last year. Margins are naturally worse than AWS and Azure as Google Cloud does not benefit from the same efficiencies at scale; however, it is positive to see strong QoQ and YoY improvement in operating margin as it bodes well for future performance at a larger revenue scale.

Source: Alphabet

This acceleration in Q4 also helped narrow the gap to 4 percentage points with Azure, compared to 7 percentage points in the previous quarter. Google Cloud had previously topped Azure’s growth rates in late 2022 and the first half of 2023 before a rather swift deceleration in Q3. What’s crucial here over the next few quarters is Google Cloud continuing to close this growth rate gap with Azure, and possibly surpass Azure once more — it should be theoretically easier to realize higher growth rates at a smaller scale, more so when leveraging AI.

Like AWS and Azure, Google Cloud is seeing strong momentum with AI products. Management said that the “strong demand we are seeing for our vertically integrated AI portfolio is creating new opportunities for Google Cloud across every product area,” while its generative AI portfolio helped win and expand deals. CEO Sundar Pichai said that “greater than 70% of gen AI unicorns are using Google Cloud,” and customers including Anthropic and Mistral AI are building and serving LLMs on Google Cloud’s AI Hypercomputer, which combines Google’s “TPUs and GPUs, AI software and Multislice and Multi-host technology to provide performance and cost advantages for training and serving models.”

Google Cloud led the charge in monetizing AI via subscriptions with Duet AI for $30/month, and management noted that customers are “increasingly choosing Duet AI” to “boost productivity and improve their operations.” Duet AI will soon incorporate Google’s Gemini, its multi-modal family of LLMs developed to challenge OpenAI’s GPT-4. Google Cloud is “intensely focused on bringing the benefits of Gemini” to its cloud customers, and the rollout of the top iteration, Gemini Ultra, at a $20/month subscription could help Google gain share away from OpenAI and thus Azure while increasing revenue.

Conclusion

Big Tech’s cloud units reported strong growth in calendar Q4, with AI helping drive a noticeable acceleration for Azure while AWS and Google Cloud touted strong contributions from generative AI products. The trio all possess the necessary ingredients for sustained accelerations or maintained growth at higher levels: increased customer migrations, larger and longer duration contracts, monetization opportunities within the suite via subscriptions, and improvements in productivity and cost reductions for cloud customers.

I/O Fund Equity Analyst Damien Robbins contributed to this analysis.

Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.

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Cloudflare 3Q23 Earnings Summary

Posted on November 3, 2023June 30, 2026 by io-fund

Cloudflare reported revenue and EPS above consensus. However, 4Q23 revenue guidance missed consensus by ~1% due to geopolitical uncertainty and macro headwinds. The other positive thing to note was that Dollar-Based Net Retention Rate (DBNR) improved to 116% for 3Q23. Management believes DBNR will stabilize near these levels and it will take some time for its efforts to improve Go-to-Market execution to be shown in DBNR, which we see as a positive.

Despite the same macro headwinds that Cloudflare is facing along with other software companies, we believe there is strong demand and need for Cloudflare’s products such as Area 1 and its developer platform, Cloudflare Workers. Longer term, we believe NET will significantly benefit from the AI inference opportunity, which we previously highlighted in our Cloudflare: Bringing AI Inference to the Edge note. Currently NET has inference optimized GPUs in 75 cities globally as of the end of October 2023 and is on track to be in 100 cities by end of CY23.

Revenue and EPS

Revenue: $335.6 (up 32% Y/Y) above consensus of $330.6M (+30% Y/Y).
Non-GAAP EPS: $0.16 above consensus of $0.10
NET gave 4Q23 revenue guidance of $352.5M, at the midpoint below consensus of $356.3M (+30% Y/Y)
· Commentary from call: “Moving onto the guidance for the fourth quarter and the full year, with broadening geopolitical uncertainty and increasingly mixed macroeconomic data points across geographies. The business environment in which we operate remain challenging to predict, and as a result, we continue to remain prudent and cautious in our outlook for the fourth quarter”.
Non-GAAP EPS guide: $0.12 above consensus of $0.10.

Margins

Non-GAAP Gross Margin: 78.7% vs. 78.1% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Gross Margins expanded from 77.7% to 78.7%
Non-GAAP Operating Margin: 12.7% vs. 5.8% in 3Q22
· From 2Q23 to 3Q23, Non-GAAP Operating Margin expanded from 6.6% to 12.7% due to OpEx as a % of revenue going down 5% Q/Q and going down 6% Y/Y to 66% of revenue.

Cash Flow

$34.9M (10% FCF Margin) vs. ($4.6M) (-2% FCF Margin) in 3Q22
· From 2Q23 to 3Q23, FCF Margins expanded from 6% to 10%
· Commentary from call “This is a business that can generate significant cash, and in 2023, we expect we will generate more than $100 million in free cash flow, well ahead of our original goal when we started the year, and the direct result of improved execution across our entire business.”
· Network CapEx: 8% of revenue.
· FY23: expects network CapEx to be 8-10% of revenue vs. 10-12% previously. However, they expect network CapEx to return to normalized levels over a period. We had highlighted earlier in our analysis that network CapEx is the primary reason why FCF can be minimal at times.

Key Business Metrics

Paying customers: 182,027 (+17% Y/Y)
· Commentary from call: “We added a record number of net new customers year-over-year, spending more than $500,000 and $1 million on an annualized basis with Cloudflare”.
Paying customers with more than $100K ARR: 2,558 (+34% Y/Y)

Dollar-Based Net Retention (DBNR): 116%
· Commentary from call: “We continue to believe the recent decelerating trend in DNR stabilizing near these levels”.

DBNR expanded from 115% in 2Q23 to 116% in 3Q23.

Go-To-Market (GTM)

NET’s pipeline close rates held firm.
· Commentary from call: “During the quarter, the pipeline generated by this new cohort was 1.6 times higher than those brought on at the same time a year earlier. These new account executives achieved more than 130% of their activity goals for the quarter”.
NET’s salesforce productivity remained stable and linearity in terms of when deals were closed was similar to Q2.
· Commentary from call: “I think that we have been able to hold things steady while making significant organizational changes and improvements across our sales and marketing organization is very encouraging. Beyond that, we’re beginning to see positive early signs from the sales team members we’ve brought on over the six months to replace underperformers.”

Conclusion

Cloudflare may require more than one entry. Cloud has been volatile, and NET can produce choppy reports. We plan to use technical analysis to its fullest.

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Microsoft Pre-ER: Will We See Evidence of a Bottom?

Posted on April 24, 2023June 30, 2026 by io-fund

Microsoft will report its Q3 FY23 results on April 25th. The company is one of the most anticipated earnings reports in determining cloud trends. The company’s overall revenue in Q2 was in line except for the personal computing miss (which was substantial, but is also well-known).

Azure posted slightly-better-than-expected growth of 38% compared to guidance of 37%. However, the Azure guidance for Q3 is for 30%-31% growth, which marks a sharp deceleration. The CFO also pulled fiscal year guidance, which is unusual for Microsoft. One key metric that could make or break Microsoft’s report will be if Azure has bottomed or if there is further decline.

What we are watching:

Revenue guidance for March quarter missed slightly by about $1.5 billion for a guide of $51 billion at the midpoint. This represents 3.3% growth compared to 6.7% growth expected. The guidance for the next quarter will be in focus.

Consumers are weaker than expected. Not only did More Personal Computing miss in Q2 but this segment is causing enough uncertainty that the CFO did not provide a fiscal year guide. Any insights in the earnings call are to be watched.

Azure guidance is at 30% to 31% growth for the March quarter down from 38% this quarter and down from 49% on CC basis in the year ago March quarter. We are keenly watching if Azure will bottom by not reporting sequential deceleration.

Customers exercised caution in the commercial cloud business. The company’s CFO Amy Hood said in the last earnings call. “In our commercial business, we delivered strong growth in line with our expectations. However, as you heard from Satya, we are seeing customers exercise caution in this environment and we saw results weaken through December. We saw moderated consumption growth in Azure and lower-than-expected growth in new business across the standalone Office 365, EMS and Windows commercial products that are sold outside the Microsoft 365 suite.”

Management comments in the commercial business are to be watched. The management in the previous earnings call provided guidance for the commercial business to grow 20% in the FY 23. They did not give a guidance in Q2 and instead said that revenue grew 20% in H1 and management expects it to further decelerate in H2.

Financials

Estimated Revenue:

Below, you can see that Microsoft is expected to bottom on growth. We talked about the H2 rebound in our most recent webinar. To some extent, the market is front running this rebound as anything can happen in the upcoming earnings reports. Regardless, Microsoft is a safer bet than others that revenue will rebound given its cloud suite drives down costs for enterprises.

· Q3 FY 23E (Mar 23): 3.41%

· Q4 FY23E (Jun 23): 5.82%

· Q1 FY24E (Sept 23): 9.09%

· Q2 FY24E (Dec 23): 10.44%

On a FY basis, Microsoft is expected to report the following – again, we are seeing evidence the next two quarters *should* be the bottom for Microsoft. We will want confirmation of this in the upcoming ER.

· FY June 2022 Actuals: 17.96%

· FY June 2023E: 5.37%

· FY June 2024E: 11.52%

· FY June 2025E: 13%

Microsoft has some of the strongest margins across the FAAMG stocks. For EPS, Microsoft is expected to report:

· Q2 FY 23 (Dec 22A): $2.20

· Q3 FY 23 (Mar 23E): $2.24

· Q4 FY23 (Jun 23E): $2.47

· Q1 FY24 (Sept 23E): $2.57

· Q2 FY24 (Dec 23E): $2.66

Cash Flow:

Cash flow was affected by the TCJA R&D tax payment of $2.355 billion. There is a new tax law that changes how R&D expenses are taxed, which you can read about here referred to as “Tax Cuts and Jobs Act” or “TCJA.”

Operating cash flow was $11.2B down (23%) year-over-year. Excluding the tax payment of $2.355 billion, Op Cash Flow was down (7%). Free cash flow of $4.9 billion was down (43%) YoY. Excluding the tax payment of $2.355 billion, FCF was down (16%).

Operating cash flow margin was 21.18% and adjusted excluding the tax payment was 25.65% compared to 28% in the same quarter last year. Free cash flow margin was 9.29% and adjusted excluding the tax payment was 13.75% compared to 16.65% in the same period last year.

For next quarter, the company expects to make a TCJA R&D tax payment of $1.2 billion.

The company returned $9.7 billion to shareholders with $4.6 billion in share repurchases and $5.1 billion in dividends. The company had cash and investments of $99.51 billion and debt of $48.12 billion at the end of the December quarter.

Noteworthy:

The management had highlighted in the last earnings call that the company is well positioned to capture the opportunity in AI. Satya Nadella said, “We have the most powerful AI supercomputing infrastructure in the cloud. It’s being used by customers and partners like OpenAI to train state-of-the-art models and services, including ChatGPT.”

We had written about the company’s dominance in AI before Chat-GPT3 was released and the market was buzzing about AI. We had said in our premium article in October last year, “Microsoft is a sleeping AI/ML giant. Google gets a lot of attention here yet I think they are equally prepared to serve this market. Maybe Microsoft even more so because of its penetration in the Fortune 500, which are the companies most likely to invest in AI/ML for the practical reason it requires a certain size budget.”

“To help Microsoft rival Google and DeepMind, the company has been investing in OpenAI, which is a large R&D operation that is breaking ground with AI algorithms that help computers to create images from text, reduce the amount of code that developers need to write, and to also help robotics think and act like humans, among other things. GPT-3 is the language generation model that has gotten quite a bit of attention for its ability to build websites and games using a language like English rather than a programming language. As of now, GPT-3 is known as the advanced text autocomplete program.”

Margins:

The Q2 one-time charge related to layoffs negatively impacted gross margin by $152 million, operating income by $1.2 billion, and earnings per share by $0.12. We would like to see consistency in the margins.

· Gross margin of 67% which was in line and flat YoY. The management guidance for the next quarter is 69%.

· GAAP operating margin of 38.8% and adjusted operating margin of 41% compared to GAAP OM of 43% in the year ago quarter. The management guidance for the next quarter is 40%.

Microsoft is looking to maintain the bottom line despite the weakness in consumer. The company’s CFO said in the last earnings call, “As a result, when excluding the Q2 charge and favorable impact from the change in accounting estimate, we expect full year operating margins to be down roughly 1 point in constant currency and roughly 2 points in USD, even with the headwinds from materially lower OEM revenue and higher energy costs.”

According to the preliminary results by IDC, there was a YoY decline of (29%) in the shipments of traditional PCs in Q1 2023 due to weaker demand and excess inventory. IDC expects growth after 2023. So, we expect that the Personal Computing Segment will be weak in the March quarter. Below is the management guidance for the various segments in the next quarter:

· Productivity and Business Processes is 8% YoY at the mid-point. (11% to 13% YoY in CC).

· Intelligent Cloud is 14.7% YoY at the mid-point. (17% to 19% YoY in CC).

· More Personal Computing a YoY decline of (16.7%) at the mid-point.

· Microsoft Azure is 30% to 31% YoY growth in CC.

We believe that there are chances for Microsoft to bottom first in Cloud before AWS or Google Cloud since Microsoft aggregate cloud services help to 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. Microsoft is a hybrid cloud leader which attracts large enterprises and its ability to reduce costs with its tech stack.

Recent Headlines and updates:

The company announced last month that the new AI-powered Bing and Edge has a good response. The company crossed 100 million daily active users of Bing. “Of the millions of active users of the new Bing preview, it’s great to see that roughly one third are new to Bing. We see this appeal of the new Bing as a validation of our view that search is due for a reinvention and of the unique value proposition of combining Search + Answers + Chat + Creation in one experience.”that roughly one third are new to Bing. We see this appeal of the new Bing as a validation of our view that search is due for a reinvention and of the unique value proposition of combining Search + Answers + Chat + Creation in one experience.”

The company introduced Microsoft 365 Copilot last month. It is the productivity tool that combines large language models (LLMs) with the data in Microsoft Graph and Microsoft 365 apps. The use cases of Copilot in Word include giving the users the first draft while saving the time on sourcing, writing, and editing the content. Similarly, Copilot in PowerPoint will help to create presentations based on the previous content. Copilot in Excel can analyze trends from the data, create charts, and helps to make informative decisions.

The company announced in February that is has previewed two AI-powered services that are designed to manage telecom networks. Jason Zander, executive vice president of strategic missions and technologies at Microsoft said, “What we’re doing is taking our native cloud work and making it specific to this telecom operator network space. I think a really great example of that is all the AI ops work that we are introducing into the system."

The company showed a demo to ad agencies on how the company plans to monetise the new Bing search. One of the ad executive noted, “The company said it is taking traditional search ads, in which brands pay to have their websites or products appear on search results for keywords related to their business, and inserting them into responses generated by the Bing chatbot.”

The UK’s Competition and Markets Authority after receiving feedback from industry participants have dropped some of the key concerns in the Microsoft and Activision deal. The CMA is expected to make a final decision on April 26.

What Analysts are Saying/Channel Checks:

Wedbush analyst Daniel Ives raised the firm's price target on Microsoft to $315 from $290 and keeps an Outperform rating on the shares. The firm's recent checks have been positive around overall cloud deal flow and momentum for Microsoft in the quarter and thinks the company should see at least low 30% Azure growth. He also believes that Microsoft could be in a position to take market share from Amazon AWS over the next 12 to 18 months. “There have been spots of softness, particularly in the financial space, but federal deals look to be strengthening, as Amazon (AMZN), Google (GOOG) (GOOGL), Oracle (ORCL) and IBM (IBM) have also seen a surge of Beltway cloud deal activity this year as the federal government enacts a major shift to the cloud.” Wedbush believes ChatGPT will be the next gear of growth for Microsoft over the coming years. The analyst further said, "We continue to believe the first step for MSFT was Azure/Office 365 with the next step ChatGPT/AI monetization on both the consumer and enterprise fronts combined adding $20 per share to MSFT's sum-of-the parts valuation as this execution story plays out,"

UBS analyst Karl Keirstead lowered the firm's growth estimates for Microsoft's Azure cloud segment, saying that recent trends have continued into Q1. The analyst, who made no change to the firm's Neutral rating or $275 price target, feels the Street's estimates for Azure are too high and concludes that customer efforts to optimize/trim their cloud spend will be deeper and last longer than most think based on calls with AWS/Azure customers and partners. UBS contends that the potential for a worse-than-Street-consensus Azure growth outlook creates some downside risk into the print.

Morgan Stanley says the firm's most recent CIO survey points to stable IT spending and suggests "favorable Microsoft-specific fundamentals." The firm sees several forward looking indicators in the CIO survey that support Microsoft's "strong relative positioning" if 2023 budgets come under further pressure, noting that Microsoft widened its substantial lead in expected IT wallet share gains. The firm, which calls Microsoft "increasingly well positioned" based on its survey work, has an Overweight rating and $307 price target on the shares.

Oppenheimer analyst Timothy Horan raised the firm's price target on Microsoft to $310 from $280 and keeps an Outperform rating on the shares. With the company now having introduced AI Co-Pilot betas across all Office, Cloud, and PC segments, the firm's initial estimate is approximately 3-5 points of incremental annual revenue growth ramping in 2025. This estimate balances the transformative nature of GPTAI, Microsoft's relationship with OpenAI, and large synergy opportunities as Microsoft has purposely understated pricing to spur early adoption.