Prediction: Microsoft Azure To Reach $200 Billion In Revenue By 2028

Posted on September 9, 2024June 30, 2026 by io-fund

This article was originally published on Forbes on Sep 05, 2024, 11:03pm EDTForbes on Sep 05, 2024, 11:03pm EDT

The period after the dot-com bubble including the financial crisis of 2008 were difficult years for Microsoft. The stock returned a mere 37% compared to Amazon’s 657.9% in the same time frame and Apple’s 5150%.

Microsoft’s stock greatly underperformed prior to Satya Nadella as CEO. Source: YChartsYCharts

Microsoft’s trajectory changed when Satya Nadella, formally of the Azure division, became CEO in 2014 after working his way up through the company over the course of 19 years to president of the cloud business. The stock is up 1,000% in the ten years since Nadella took the helm using his multi-decade cloud experience to steer a remarkable turnaround from a corporate reputation mired in fighting open-source communities and anti-trust issues. Since Nadella became CEO, the returns in Microsoft’s stock have exceeded Amazon and is tied with Apple, as of writing.

Microsoft’s stock has outperformed since Satya Nadella became CEO in 2014. Source: YChartsYCharts

The competitor Nadella faced in building Azure is arguably the toughest competitor in technology – Amazon Web Services (AWS); not only for the vendor lock-in qualities of cloud IaaS as migrating a tech stack is quite costly in both time and money, but also because AWS had the first mover advantage of a four-year head start. In the tech industry, a lead this long is considered insurmountable.

Over the past ten years, Microsoft strategically exceled by targeting the Fortune 500 with 85% running on Azure today. Retaining the Fortune 500 in the migration to the cloud was accomplished 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. As the leader in on-premise systems, Microsoft was perfectly positioned to win with hybrid architectures. The company took this a step further and undercut other services on prices across its suite of software and platforms to win aggregate, long-term contracts.

This past month, for the first time, Microsoft has announced it will be re-organizing its reporting segments, which will afford investors a better apples-to-apples comparison between Azure and AWS. According to Wells Fargo, the new Azure reporting segment stands at an estimated $62 billion as of June 2024, compared to $105 billion for AWS.

The lead we see from Microsoft today on AI revenue streams is critical enough and predictive enough that it points toward Azure surpassing $200 billion by 2028, catalyzed by the OpenAI investment, Copilot’s rapid integration into nearly every Microsoft software product, having the ace of spades — which is an operating system used in 72% of the world’s laptops and desktops, and perhaps the simplest reason of all —- Microsoft excels at the enterprise.

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New Azure Reporting Reveals 11-Points of AI Contribution

Microsoft offers investors unique insights as to the monetization opportunities for AI. Last year, in the FY2023 Q4 report ending in July, Azure officially inflected due to AI. Per the report: “Azure and other cloud services revenue grew 26% and 27% in constant currency, including roughly 1 point from AI services.” In four brief quarters, Microsoft is now reporting an 8% inflection from AI: “Azure growth included 8 points from AI services where demand remained higher than our available capacity.”

Later, it was stated in an updated FY25 investor presentation that Azure saw an 11 point contribution last quarter compared to the 8 points previously reported. The metric change is due to Microsoft removing Enterprise Mobility + Security (EMS) and Power BI (BPP) from Intelligent Cloud. It’s significant that Azure is seeing low double digits while AWS and Google Cloud are not reporting their exact contribution from AI, rather are remaining vague by saying “several billions” in AI revenue.

The reporting changes also update Azure’s growth rate to 33% for the fiscal year and an impressive 35% growth in constant currency. Prior to the metric changes, management guided for a slight deceleration in Azure growth in Q1’25, with growth of 28% to 29% in CC (vs 30% this quarter), yet they expect an acceleration in H2’25 as their capital investments increase AI capacity.

Microsoft Azure recently updated metrics to show higher AI contribution of 11 points. Source: MICROSOFT FY25 INVESTOR METRICS

According to Wells Fargo, the new metrics suggest an annualized run rate for Azure of approximately $62 billion. Investors will get the official number in next quarter’s earnings report.

Management has stated the primary issue is being capacity constrained, which all things equal, is bullish for the medium-term as it implies demand exceeds supply for Azure AI and Azure’s consumption business. Per management in the most recent earnings call: “And in H2, we expect Azure growth to accelerate as our capital investments create an increase in available AI capacity to serve more of the growing demand.”

Azure AI is a platform for developing custom AI applications and solutions. Companies use Azure AI to integrate generative AI and multimodal language models into their applications for features such as search, image recognition, natural language processing, speech to text and other AI features using developer tools, such as APIs and SDKs. The platform also offers lifecycle management for data preparation and model development and training for machine learning, supporting popular frameworks PyTorch and Tensorflow. Azure OpenAI provides access to OpenAI’s GPT-4, GPT-3.5, Microsoft’s DALL-E models, and Meta’s Llama models for companies to build custom generative AI applications and AI assistants. Companies run models on their data to improve workflows through Azure AI Studio.

Azure AI customers totaled more than 60,000, implying customer growth rate of nearly 60% YoY and up over 13% vs Q2’24 with average customer spend continuing to grow. The number of Azure AI customers using data and analytics tools also grew nearly 50% YoY.

Where Azure stands apart is that its security segment is one of the largest in the world. In 2023, it was stated Microsoft’s security segment was at $20 billion with 860,000 customers. The number of customers has been updated to 1.2 million, and if we do some simple math, that would imply the security segment is at $28 billion today – far exceeding all best-of-breed cybersecurity companies combined.

Also tied to Microsoft’s strong presence in security, the Federal Government often gets overlooked in terms of its AI impact to Azure. In a blog post, the company CTO Bill Chappell wrote: "[…] generative AI capabilities through Microsoft Azure OpenAI Service, can help government agencies improve efficiency, enhance productivity, and unlock new insights from their data. Many agencies require a higher level of security given the sensitivity of government data. Microsoft Azure Government provides the stringent security and compliance standards they need to meet government requirements for sensitive data."

Key metrics for Microsoft have been on fire lately. Bookings increased 17% YoY and 19% on a constant currency basis. This was significantly above expectations and driven by growth in the number of $10M+ and $100M+ contracts for Azure and Microsoft 365. This compares to 29% growth (31% on CC basis) in Bookings last quarter and compares to a -2% decrease (-1% on CC basis) in Bookings in the year ago quarter. Commercial RPO grew by 20% YoY to $269 billion. This compares to 20% growth last quarter and 19% YoY growth in the year ago quarter.

Source: I/O Fund Stock ResearchI/O Fund Stock Research

If Azure were to continue its growth rate today on the assumption that any acceleration from AI offsets a deceleration on traditional cloud revenue (due to repatriation from moving cloud workloads to on-prem, for example), then Azure would reach revenue of $178.3 billion by 2028. That’s the bare minimum base case.

If we assume that AI contributes an additional 10 points for the next two years, and then tapers off to 8 points of AI contribution, and finally 4 points of AI contribution due to a higher revenue base, while also offsetting up to a 6-point decline in traditional cloud workloads, then Azure will reach $206.7 billion by FY2028 (ending in June of 2027).

Source: I/O Fund Stock ResearchI/O Fund Stock Research

There are some analysts forecasting $41.6 billion for AI revenue for AWS by 2027. It’s reasonable to assume Microsoft’s AI revenue will be higher as it’s the only company reporting details on AI revenue across the Big 3 and at a double-digit percentage of 11% nonetheless (or about $7 billion in AI revenue) compared to vague comments of “several billions” of AI revenue from Azure’s competitors, and likely to be the $3 to $4 billion range. Therefore, assuming Microsoft has $55 billion in revenue by 2027 compared to AWS’ $42 billion is a reasonable assumption.

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Copilot’s Rapid Integration

While OpenAI’s Chat-GPT and Google’s Bard /Gemini have gotten all of the attention, Microsoft has been quietly building an AI software empire with Copilot. Copilot features are designed to boost productivity and are integrated across consumer and enterprise software, including Windows, Edge, Office, Bing, Teams, Loop, Dynamics and Viva.

Copilot utilizes large language models that require Azure consumption. To prepare for this moment, Microsoft invested $1 billion in Open AI in 2019. Over the last five years, Microsoft has increased its investment to $13 billion. Open AI’s Chat-GPT are some of the large language models that power Microsoft’s Copilot. OpenAI leads the market on LLMs and every time Chat-GPT is integrated into a product and used across OpenAI’s user network, money funnels to Azure as Microsoft is the exclusive cloud provider in exchange for allowing OpenAI to access Azure’s infrastructure at a reduced cost. Around the time that Chat-GPT was noticed by Wall Street, Microsoft’s management team said the following about its impact on Azure:

“Second, even Azure OpenAI API customers are all new, and the workload conversations, whether it’s B2C conversations in financial services or drug discovery on another side, these are all new workloads that we really were not in the game in the past, whereas we now are.”

Developers pay between $10 to $19 per month for GitHub Copilot. According to the most recent earnings report, Copilot accounted for over 40% of GitHub’s revenue growth this year and is already a larger business than all of GitHub when Microsoft acquired it at $2 billion annual recurring revenue (ARR). GitHub Copilot has been adopted by over 77,000 companies, up 180% YoY.

Copilot Studio, a low-code tool for creating and maintaining copilots, saw a 70% QoQ increase in organizations using it to 50,000.

Copilot for Sales and Service is priced at $50 per user each, Copilot for finance is $30 per user, and for Dynamics data platform use cases, it’s priced as high as $1,397 per tenant. The highest cost is Copilot for Security, priced at $4 per hour, with an estimated monthly cost of $2920.

Although some of the upside from Copilot will be reported in other revenue segments outside of Azure, there are some tie-ins regardless of where Copilot is running. For example, enterprises need data to reside where Copilot can access it, which implies higher Azure revenue. On a more granular level, those who subscribe to Office 365 are often locked-in to Azure Active Directory (AD).

Today, Microsoft has more than 400 million 365 Commercial customer seats and 78.4 million 365 Consumer subscribers, giving a nearly ~480 million customer base to target for AI services. Assuming AI PCs help to spark a strong growth trajectory for Copilot, just a 10% adoption rate across both Commercial and Consumer by the end of the fiscal year would surpass $17 billion annual run rate. It’s likely the 10-year adoption rate will be well above 50% with an addressable market of up to 90% as more AI assistant productivity hacks are developed. This means Office 365 would land somewhere between $86 billion and $156 billion, equal to the current size of Azure or up to double the size of Azure on this revenue stream alone.

While Wall Street is worried about how much AI is costing, the I/O Fund is busy calculating how big the AI opportunity can get in the next few years and how investors can participate. Join our next webinar on Thursday September 12th where the Portfolio Manager will discuss potential entries for Microsoft and other AI-related stocks.our next webinar on Thursday September 12th where the Portfolio Manager will discuss potential entries for Microsoft and other AI-related stocks.

Copilot for Microsoft 365 is priced at $30 a month. The productivity tool combines large language models (LLMs) with the data in Microsoft Graph and Microsoft 365 apps. The use cases of Copilot in Word include giving 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 previous content. Copilot in Excel can analyze trends from the data, create charts, and assist in making informative decisions.

In the second full quarter of availability, the number of people using Copilot for Microsoft 365 nearly doubled QoQ. Copilot customers increased 60% QoQ and the number of customers with over 10,000 seats more than doubled QoQ.

Power Platform, a collection of low-code development tools, saw MAUs rise 40% YoY to 48 million. 480,000 organizations have also used the AI-powered capabilities in Power Platform, up 45% QoQ. As stated, Power Platform will no longer be reported in Microsoft’s Azure segment

Copilot on the Verge of Becoming Ubiquitous

Windows operating system is in 72.3% of desktop and laptops. When you consider that Windows has most recently launched on an Arm-based PC with Qualcomm, and will also launch next year with AMD and Nvidia, that market share is likely to grow rather than contract. Similar to the penetration rate of Office 365, Windows dominates PCs regardless if the OEM is Dell, HP, Lenovo, Acer, Asus, LG, Samsung or Microsoft Surface.

Copilot+ for Windows is a sidebar that helps Windows users change settings, find files or summarize text across a desktop. Recall is a feature that helps a Windows user find documents, emails and web pages when a user simply states how they recall the file or digital asset. On some Surface laptops, there is a Copilot key, a digital pen enhanced with AI, sound and voice features enhanced with AI, and enhanced AI cameras.

Both Arm-based and x86 AI PCs are ramping this year with a CPU + GPU + NPU combo that will, in turn, proliferate Copilot+ for Windows, the AI assistant that requires a minimum of 40 TOPS (trillions operations per second). The neural processing units (NPUs) are powerful enough to deliver the official kickoff of AI edge computing as Copilot+ runs AI tasks locally on the AI PC and integrates them into various applications. This is an important moment for AI as prior to NPUs exceeding 40 TOPS, workloads were primarily sent to the cloud. By running AI assistants locally on the computer, suggestions will be faster and more accurate.

Qualcomm’s Snapdragon X Elite and Plus processors were released this last summer and offer the first GPU, CPU and NPUs that exceed 45 TOPS for AI tasks for Microsoft’s Copilot+ with a long battery life of over 12 hours. This week, Intel released its second-generation Core Ultra chips capable of reaching 48 TOPS that offers a long battery life of over 10 hours with the added benefit of running legacy x86 software without compatibility issues.

Canalys is projecting AI PC shipments to rise at a 44% CAGR from 2024 to 2028, from an estimated 48 million PCs this year, before doubling to more than 100 million in 2025 and rising to over 205 million by 2028. Cumulative shipments of AI PCs are projected to surpass 600 million over the next four years. I’ve covered additional information on the growth of the AI PC market here.

Within this rapid growth, commercial adoption is forecast to be higher, at approximately 60% by 2028 versus 40% for consumer. This is due to the productivity gains that AI PCs can enable via powerful on-device AI as well as benefits to software developers and related roles. For example, Dell’s XPS and Latitude 7455, equipped with the Snapdragon X Elite can support 13 billion-plus parameter models which means customers can run popular models like Llama 3 directly on their PCs. The fact that commercial adoption will be higher than consumer adoption is a boon for Microsoft Copilot and its suite of enterprise AI-enabled applications and platforms.

Microsoft’s Capex Spending Highest Among Cloud IaaS Providers

Microsoft is unabashedly spending tens of billions on AI infrastructure. In the last earnings report, the company announced strong QoQ increase to its capex for AI infrastructure. Capex was $14 billion last quarter, when it grew 22% sequentially. Microsoft’s capex increased 36% sequentially and 78% YoY to $19 billion in Q4.

Full year 2024 capex was up 75% YoY to $55.7 billion, yet this quarter’s run rate suggests we could see up to $80 billion in capex in FY2025. Compare this to cloud IaaS leader AWS which reported H1 capex of $30.5 billion for a run rate in capex of just over $60 billion. Notably, management is guiding for a further YoY increase in capex in FY’25. I have covered the importance of Big Tech’s capex for AI stocks in an analysis here and also in a previous webinar.an analysis here and also in a previous webinar.

Big Tech management teams have been getting an earful from Wall Street on when investors can expect to see a return. Private investors are busy calculating what level of revenue these companies must generate, estimating the return will need to be as high as $600 billion to justify the revenue Nvidia has reported in its data center segment.

Therein lies the disconnect, which is that Microsoft’s CFO, Amy Hood, states they are capacity constrained – implying the opposite problem, that the capex they’ve allocated is not nearly enough to serve Azure AI demand. Per the last earnings call: “We are – and we've talked about now for quite a few quarters, we are constrained on AI capacity. And because of that, actually, we've, to your point, have signed up with third parties to help us as we are behind with some leases on AI capacity. We've done that with partners who are happy to help us extend the Azure platform, to be able to serve this Azure AI demand. And you do see us investing quite a bit as we've talked about in builds so that we can get back in a more balanced place.”

Microsoft’s management team also pointed out about 40% of capex is spent on land, which is a long-term asset, and the rest is tied to a demand signal for inference. The CFO stated: “even in the capital spend, there is land and there is data center build, but 60-plus percent is the kit, that only will be bought for inferencing and everything else if there is demand signal.”

Therefore, investors have an important decision to make. On one hand, investors could listen to the bearish undertones that high capex spending will not be returned to investors over time, or on the other hand, view high capex spending as a bullish signal of the overflow in demand that will sustain for many years to come, with AI consumption well exceeding the capex being spent to build the infrastructure.

Conclusion:

In 2022, I wrote an 8,300 word analysis entitled Special Report: The New Kings of Tech for our research members that tied together key points on how to position our readers for AI’s big moment – well in advance of Nvidia’s stock surge. Part of this analysis was to emphasize that our readers should shift their mindset from consumer-facing stocks to enterprise-facing stocks. This is not easy to do given the FAANGs are primarily consumer stocks, and it was consumer that drove historic gains for the market over the past decade.

Here is what I wrote at the time:

“The adage is that history rhymes but it does not repeat. I believe a large addressable market is certainly required to produce the new wave of FAANGs – however, rather than consumer driving the gains, I believe it will be enterprises. Below, I discuss the enterprise-level market that will be four times larger than mobile and two stocks that will directly participate. Imagine participating in 4X the FAANGs by 2030. That’s what I believe will happen due to one key trend and I discuss exactly why this will be achieved below.” -I/O Fund’s Special Report: The New Kings of Tech, June 5th 2022

Nowhere will the AI enterprise advantage be more evident than with Microsoft’s steady ascent over the next ten years, which I believe will end with Microsoft firmly on top in nearly every category the company competes in. A few years ago, I predicted Nvidia would Surpass Apple by 2026. At the time, Nvidia had a $550B market cap and the mere thought was inconceivable . To that point, I purposely did not say Nvidia would surpass Microsoft — as once the AI opportunity fully plays out —- this company will be a tough one to catch.

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Microsoft FYQ2: Guidance Weaker than Expected

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

Microsoft was up 5% after hours yet this reversed due to comments on the earnings call.

Ultimately, the guidance on the earnings call was weaker than expected in a few key areas:

Revenue growth for the March quarter had a slight miss.
Intelligent Cloud for next quarter is marking a 6-point deceleration sequentially and a 10-point deceleration YoY.
Azure is contributing to the deceleration in Intelligent Cloud with a 4-5 point deceleration sequentially from the exit rate in December (see below transcript for clarification from CFO). This puts Azure 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. You may recall, the 5 point deceleration announced in the October report caused concern in the market. This is technically a steeper decel – comments from CFO clarifying this are below.
Commercial Cloud growth guidance of 20% for Fiscal Year 2023 (provided on last two calls) was essentially pulled and CFO said would decelerate in H2. Overall FY2023 guidance was not provided, which is out of character for MSFT. CFO cited it was due to consumer.
The consumer is weaker than expected. Not only did More Personal Computing miss this quarter but this segment is causing enough uncertainty that the CFO did not provide a fiscal year guide.

FINANCIALS:

The current quarter was in line across the board — except the Personal Computing miss – which led to a slight miss on the top line. Azure posted slightly-better-than-expected growth of 38% compared to guidance of 37%. GAAP EPS missed while adjusted EPS beat. FCF was down quite a bit from the previous year FQ2 due to one-time expenses and consumer weakness. We break the one-time expenses down below.

Microsoft reported revenue of $52.7 billion, which missed estimates of $53.2B or by about $500 million. The market overlooked this initially because the miss was driven by the PC/consumer segment whereas Intelligent Cloud beat. Notably, the revenue this quarter was in line with guidance from management.

The guide on revenue came in at $51B at the midpoint and $51.5B at the high end of guidance, which missed expectations of $52.6B or by about $1.5 billion. This represents 3.3% growth compared to 6.7% growth expected.

As noted, the full year guide was essentially pulled as the CFO did not state a FY2023 guide despite giving us one in the past two quarters. The understanding is that the full year revenue would “grow double digits.”

Here is what was stated on the earnings call in the previous quarter:

"At the total company level, we continue to expect double-digit revenue and operating income growth on a constant currency basis. Revenue will be driven by around 20% constant currency growth in our commercial business, driven by strong demand for our Microsoft cloud offerings. That growth will be partially offset by the increased declines we now see in the PC market.”

This was shared in the earnings call this evening but is pretty vague: “First, in our Commercial business, revenue grew 20% on a constant currency basis in H1. However, we now expect to see a deceleration in H2, given how we exited December.”

Below, I include more information from the transcript. However, the Commercial business decelerating in H2 indicates it’s not only consumer weighing on the full year guide.

The company reported GAAP EPS of $2.20 which missed estimates of GAAP EPS $2.28 – I believe this is due to the layoffs which had a $0.12 EPS impact. The adjusted EPS was in line at $2.32.

For the current quarter, the operating margin and net margin was weaker than last year although the CFO did reiterate the FY2023 operating margin would be down (1%) YoY. Here is what was stated:

“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.” Note: this is a pretty strong OM given the weakness in consumer implying Microsoft is very good at pulling the necessary levers to maintain bottom line strength.

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. Per our Pre-ER write-up, analysts are modeling annualized net of $2 billion per year from the layoffs moving forward.

There is also 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.” This tax payment was $2.35 billion.

In addition to these one-time headwinds, the segment weighing on operating income is the More Personal Computing segment down roughly 50% in Op Income whereas both Intelligent Cloud and Productivity grew double digits or more on Op Income (on a CC basis).

Gross margin of 67% which was in line and flat YoY. On a CC basis, gross profit grew 8% YoY to $35.3 billion.
GAAP operating margin of 38.8% and adjusted operating margin of 41% compared to GAAP OM of 43% in the year ago quarter. On a CC basis, the operating profit was flat with 0% growth for $20.4 billion in Op Income.
Net margin of 31.1% compared to 36% net margin in the year ago quarter. On a CC basis, net profit was down (4%) year-over-year for $16.4B in net profit which resulted in GAAP EPS being down (3%) on a CC basis.

Cash Flow:

Cash flow was also affected by the TCJA R&D tax payment. 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%).

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

The company returned $9.7B to shareholders with $4.6B in share repurchases and $5.1B in dividends.

Earnings Call:

Below is one of the most important questions on the call as the analyst Karl K. got three important things out of the CFO: (1) the rate of deceleration in Azure as it was not clear from comment she made as to whether it’s based on the 38% FQ2 number or the 35% December exit rate number. (2) The question also got the CFO to admit they did not give FY2023 guidance and (3) it allowed the CFO to reiterate the operating margin would remain consistent even with consumer weakness.

Karl Keirstead

Thank you. This one for Amy. Amy, given the obviously tough environment, it sounds like reaching that full fiscal year 20% constant currency commercial revs guide would be tough. Is that also true for the soft guidance for 10%-plus total revenue growth for the year? And if I could just sneak in a clarification, Amy, just because it’s an important metric. When you talk about a 4-point to 5-point decel in Azure, that’s off of the 38% reported for December, right, not off the 35% exit rate? Thank you.

Amy Hood

It’s all – Karl, let me just – the first half of your question, give me a second. On the second half of your question, which is the guide of the exit rate – it’s off the exit rate on Azure of four points to five points, just to make sure that is clear. In terms of thinking about total year revenue, right, I did not comment on full year revenue as we continue, I think really just to watch the Windows PC market as it returns to pre-pandemic levels. Outside of that, as you can see, the trends are relatively consistent. So, in some points, it’s important because if you look at the operating income margin guidance that I talked about, the fact that we are guiding to really only one point of margin deceleration for the year on a constant currency basis with probably over $2 billion of headwind from the OEM business from what we had anticipated heading into the year, the focus on margins, the focus on prioritization, the focus on putting our investments into where we know they have high return, I actually feel quite good about the place that puts us in as we exit the year in terms of – and the right energy, right, or leaving the year in Q4 on leverage.

Side Note: I’ve corrected my forum comments to reflect the 35% December number instead of the 38% FQ2 number. Azure coming in 8 points lower instead of 5 points lower sequentially is important to note. It looks like the analyst originally thought the decel was off the 38% as did I.

Another important question was around the strong trend toward optimization, or basically current customers looking for where they can cut costs. As you’ll see, some of this is from the Covid bloat although I would argue that consolidation is partly responsible, which happens to every major tech trend, regardless of a pandemic. Consolidation happens because demand for a trend is extraordinary in the beginning as excitement and adoption soars, and then consumers/enterprises cut back to only what is necessary. In the past decade alone, consolidation happened to ad-tech circa 2014, mobile apps and gaming. You’ll hear me talk about this a lot moving forward because I want I/O Fund members to be prepared – depending on how deep the recession is, not all cloud companies will survive. This is the very nature of tech.

Consolidation wasn’t specifically called out but I believe the optimizations happening now will result in consolidation and more M&A activity (if the weaker companies are lucky).

What the CEO is saying is that outside of the massive headwind that inflation presents for growth … that higher prices cause lower spending = vicious cycle that drives down growth … that he believes tech will eventually overcome this and become a larger part of GDP. In the meantime, this will be the year for optimization, and Microsoft will come out stronger in the long-term due to their positioning in AI.

Here is what was said on the call:

Brent Thill

Thanks. Satya, can you give us your overall macro view? There were some comments you had made that concerned, I think many about the state of the U.S. spending environment. I am just curious if you could comment and follow-up on what you are seeing there just from a spend environment throughout the year. I think many came away with that you are seeming that you were saying it’s getting worse, not better. Can you just give us a little more color on that? Thank you.

Satya Nadella

Thank you, Brent. And first of all, I was making a comment which was sort of a global comment, not just a specific U.S. comment. I mean there is only – I always sort of subscribe to that there is only one law of gravity that I think all of us are subject to, which is inflation-adjusted economic growth in the world. And then how many times that do we grow, because as I have said in my comments that I fundamentally believe tech as a percentage of GDP is going to be much higher and on a secular basis. So, the question is how many times is it given the overall inflation-adjusted economic growth. So, that’s kind of how I look at it. Given that, I think the two things that we see, we commented on that even in the last quarter, and it’s even in the outlook, which is the thing that customers are doing is what they accelerated during the pandemic. They are making sure that they are getting most value out of it or optimizing it and then also being a bit more cautious on given the macroeconomic headwinds out there in the market. So, given those two things, the point is at some point, the optimizations will end. In fact, the money that they save in any optimization of any workload is what their cloud into workloads. And those workloads will start ramping up. And so one of the key things we are watching for, Brent, is to make sure that we are gaining share in this space through our value propositions, so and even build loyalty with our customers so that long-term, we are well positioned for share gains. So, that’s sort of fundamentally how we view it. And then the other aspect I would also say is simultaneously investing in this new AI trend, because I don’t think any application start that happens next is going to look like the application starts of 2019 or 2020. They are all going to have considerations around how is my AI inference performance, cost, model is going to look like, and that’s where we are well positioned again. So, that’s how I view it. The market, you all are better readers of, quite frankly, what’s happening out there. We can tell you what we see. What we see is optimization and some cautious approach to new workloads and that will cycle through, but we do fundamentally believe on a long-term basis, as a percentage of GDP, tech spend is going to go up.

OpenAI was discussed on the call, and the CEO said what I would expect him to say – which is that Microsoft is strong in many areas of AI. For example, Github CoPilot offers auto complete coding suggestions and has 1 million users.

Conclusion:

We continue to like Microsoft for its bottom line and its ability to sell into enterprises. I believe this is the key thing missing in many of the other mega cap companies with AI/ML and other related ambitions, which is Microsoft owns the perfect customer base to ramp AI applications – which is the large budgets of the Fortune 500. Startups drive this too but not at the scale of the Fortune 500 and Fortune 2K.

We want to build this position on any weakness although we want to be sensitive to timing as we’ve been discussing for some time now that cloud budgets may be the next shoe to drop. The lack of a FY2023 guide from the cloud bellwether, although citing consumer, didn’t provide much information in terms of what the CY2023 cloud budgets are looking like. I think reading between the lines, even without a fiscal year guide, Azure’s further deceleration next quarter isn’t painting the best picture of cloud budgets.

On a side note, I am not sure what the tax implications of TCJA will be for other companies in the tech industry given the industry’s large R&D spending. After reading about the Tax Cuts and Jobs Act, it certainly doesn’t seem like it will be isolated to Microsoft and rather it will affect R&D investments primarily made outside the United States (foreign versus domestic R&D). Perhaps other Big Tech earnings next week will help shed some light on what to expect.

Microsoft FYQ2: Guidance Weaker than Expected

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

Microsoft was up 5% after hours yet this reversed due to comments on the earnings call.

Ultimately, the guidance on the earnings call was weaker than expected in a few key areas:

Revenue growth for the March quarter had a slight miss.
Intelligent Cloud for next quarter is marking a 6-point deceleration sequentially and a 10-point deceleration YoY.
Azure is contributing to the deceleration in Intelligent Cloud with a 4-5 point deceleration sequentially from the exit rate in December (see below transcript for clarification from CFO). This puts Azure 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. You may recall, the 5 point deceleration announced in the October report caused concern in the market. This is technically a steeper decel – comments from CFO clarifying this are below.
Commercial Cloud growth guidance of 20% for Fiscal Year 2023 (provided on last two calls) was essentially pulled and CFO said would decelerate in H2. Overall FY2023 guidance was not provided, which is out of character for MSFT. CFO cited it was due to consumer.
The consumer is weaker than expected. Not only did More Personal Computing miss this quarter but this segment is causing enough uncertainty that the CFO did not provide a fiscal year guide.

FINANCIALS:

Here is what was stated on the earnings call in the previous quarter:

Below, I include more information from the transcript. However, the Commercial business decelerating in H2 indicates it’s not only consumer weighing on the full year guide.

The company reported GAAP EPS of $2.20 which missed estimates of GAAP EPS $2.28 – I believe this is due to the layoffs which had a $0.12 EPS impact. The adjusted EPS was in line at $2.32.

For the current quarter, the operating margin and net margin was weaker than last year although the CFO did reiterate the FY2023 operating margin would be down (1%) YoY. Here is what was stated:

There is also 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.” This tax payment was $2.35 billion.

Gross margin of 67% which was in line and flat YoY. On a CC basis, gross profit grew 8% YoY to $35.3 billion.
GAAP operating margin of 38.8% and adjusted operating margin of 41% compared to GAAP OM of 43% in the year ago quarter. On a CC basis, the operating profit was flat with 0% growth for $20.4 billion in Op Income.
Net margin of 31.1% compared to 36% net margin in the year ago quarter. On a CC basis, net profit was down (4%) year-over-year for $16.4B in net profit which resulted in GAAP EPS being down (3%) on a CC basis.

Cash Flow:

Cash flow was also affected by the TCJA R&D tax payment. 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%).

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

The company returned $9.7B to shareholders with $4.6B in share repurchases and $5.1B in dividends.

Earnings Call:

Karl Keirstead

Amy Hood

Consolidation wasn’t specifically called out but I believe the optimizations happening now will result in consolidation and more M&A activity (if the weaker companies are lucky).

Here is what was said on the call:

Brent Thill

Satya Nadella

Conclusion:

Microsoft Fiscal Q1 Ending in September Overview

Posted on October 26, 2022June 30, 2026 by io-fund

We posted the following on the forum. If you scroll down, I’ve added additional commentary. This is primarily driven by personal computing which is expected to decline from $17.5 billion in the December quarter last year to $14.7 billion in the upcoming quarter, at the midpoint. Productivity and Business is expected to be soft by 7 points decel YoY and Intelligent Cloud softer by 3 points deceleration YoY.

Why Microsoft Sold Off After Earnings:

Microsoft is guiding down for next quarter with analyst expectations for the December quarter at $56.04 billion compared to management guidance on the call for revenue of $52.75 billion, at the midpoint. This represents 2% growth.

The primary reason for this decel was this comment from the CEO, which is the most comprehensive view we have of Microsoft’s expected deceleration in cloud:

“With that context, this quarter, the Microsoft Cloud again exceeded $25 billion in quarterly revenue, up 24% and 31% in constant currency. And based on current trends continuing, we expect our broader commercial business to grow at around 20% in constant currency this fiscal year, as we manage through the cyclical trends affecting our consumer business.”

That’s a 11% deceleration over the next few months. Some of this may be coming from Azure as the company is expected Azure to decline 5% next quarter for its current growth rate. This will be 37% growth on a constant currency basis, down from 42% this quarter.

From the CFO:

“Revenue will continue to be driven by Azure, which, as a reminder, can have quarterly variability primarily from our per-user business and from in-period recognition depending on the mix of contracts. We expect Azure revenue growth to be sequentially lower by roughly 5 points on a constant currency basis.”

Notably, Azure missed management’s guidance by one point, coming in at 42% on a CC basis compared to guidance of 43% on a CC basis.

This was preceded by this comment, which helps provide color but didn’t stop the AH price from slipping:

“In commercial bookings, continued strong execution across core annuity sales motions and commitments to our platform should drive solid growth on a moderately growing expiry base against a strong prior year comparable, which included a significant volume of large long-term Azure contracts.

As a reminder, the growing mix of larger long-term Azure contracts which are more unpredictable in their timing, always drives increased quarterly volatility in our bookings growth rate.”

The comment is primarily about bookings which were at 37% growth on a CC basis for fiscal Q2 of last year compared to 14% on a CC basis in fiscal Q1 of last year.

However, Azure as a revenue driver did not have high comps (to clarify the comment). Our records have Azure at 46% on a CC basis for fiscal Q2 ending in December with fiscal Q1 last year at 48% on a CC basis and fiscal Q1 was at 49% on a CC basis. The neighboring quarters were both higher.

The other thing to note is the FX headwinds result in more to unpack in this particular earnings report. Some articles online are reporting substantially lower EPS and a declining net margin – however, this is a wrong takeaway from the report. At a quick glance, it could appear that Microsoft saw a net margin decrease of 14% but net margin actually saw an increase of 11%.

The lower net margin and EPS is due to a one-time tax benefit of $3.291 billion in the year ago quarter, which resulted in unusually high net income of $20.5 billion. In all previous quarters, Microsoft had $16 billion to $18 billion in net income, and thus, the $17.6 billion from this quarter is actually in-line. Excluding the one-time tax benefit, the net income in the year ago quarter would have been $17.2 billion.

Therefore, the correct EPS comparison is actually EPS of $2.35 this quarter compared to EPS of $2.27 in the year ago quarter after adjusting for the one-time tax benefit. On an adjusted constant currency basis, this is 11% growth YoY.

Regarding the segments, the rest were in line except Azure’s 1% miss. Despite the slight miss, Intelligent Cloud came in as expected at 20%. What the market is concerned about is Azure being the leading indicator for the slowing Commercial Cloud growth that was stated at the beginning of the call by the CEO (the 11-point decel).

Productivity and Business saw a slight beat with growth of 15% on a CC basis compared to guidance of 12% to 14%. Personal Computing was in line at flat growth for $13.3 billion.

Interesting enough, the CFO reiterated FY2023 guidance as “At the total company level, we continue to expect double-digit revenue and operating income growth on a constant currency basis. Revenue will be driven by around 20% constant currency growth in our commercial business, driven by strong demand for our Microsoft cloud offerings. That growth will be partially offset by the increased declines we now see in the PC market.”

Additional Commentary on Next Quarter’s Low Revenue Growth:

The 2% growth rate is being dragged down by personal computing. Here’s more on the breakdown of what to expect:

Personal Computing is expected to decline (19%) from $17.5 billion in the December quarter last year to $14.7 billion on CC basis in the upcoming quarter. This will be down from growth of 15% in the year ago quarter.

· The 19% deceleration is coming from PCs with Windows and Surface declining in the 30-percentile range.

· The segment is being held up (somewhat) by advertising with 6% growth.

· Gaming is expected to decline in the mid-teens

Productivity and Business is expected to be soft by 7 points decel YoY for growth of 11% to 13% and revenue of $16.75 billion on CC basis. This will be down from 19% in the year ago quarter.

· On-premise business is dragging down the results with a decline in the low to mid-30s

· Office 365 is expected to report seat growth and ARPU growth

· Office Consumer will decline single digits

· LinkedIn will grow low to mid-teens

· Dynamics will grow low double digits to low 20s, which is Microsoft’s business solutions and ERP such as for financials, operations and other business tasks. It’s also CRM similar to Salesforce designed for larger companies.

Intelligent Cloud will softer by 3 points deceleration YoY for growth of 22% to 24% and revenue of $21.25B to $21.55B on a CC basis. This is down from 26% growth on a CC basis.

· Azure is expected to decelerate by 5% to 37% growth on a sequential basis yet Intelligent Cloud is expected to be flat. Energy costs for Azure will be $250M per quarter. Notably, the company believes they will see more public cloud migrations from the rising costs of energy as the cost of on-prem is rising.

· Enterprise services will be in the low single digits

A note on Commercial RPO:

Commercial Remaining Performance Obligations have been oddly strong, and this was pointed out on the call. This quarter, Commercial RPO was up 31% YoY from $137 billion to $180 billion. 45% will be recognize the next twelve months and the remaining 55% will be recognized after 12 months.

This can certainly decelerate moving forward yet the management did call out that Azure tends to be volatile and so this is technically a sign of underlying strength despite the volatility. Commercial Bookings were (3%) due to FX yet was up 16% on a CC basis. This is up 2 points on a CC basis from last year.

Here is what was discussed in terms of Commercial RPO and how it translates to Azure growth:

Mark Moerdler:

Thank you. I'd like to follow-up on the last question on Azure specifically. So next quarter, you're guiding to sequential further slowing in the business. Is that the factor of optimization? Is it something else that's going on in here? How should we think about that specific component of the guidance, given the fact that you've got good bookings, strong RPO growth, et cetera?

Amy Hood:

Thanks, Mark. I'll – you're right. Let me go ahead and reiterate part of that, which is that this quarter, as you saw, we did have very good bookings growth. And within the RPO number that you're referring to, we had what we would call long-dated growth, which means we're having and seeing customers continue to sign commitments to the platform, and that goes really to what Satya mentioned is that the plans to invest here remain intact. And so, it's about both the optimization that you're talking about, and we are seeing and the guide includes that, and it also includes new workload starting. And those also may not be matched up one-to-one to see sort of a consistent pattern. And that does result in some volatility.

The other piece of it, Mark that we didn't talk on before because I was really focused on consumption is that there is per user headwinds as well, right, because we're getting and seeing some of these [loss] (ph) of large numbers in terms of the per seat business. So, there's a couple of things going on here Mark again, as you said, a very large base. So, it's not just the optimization to new workloads. It's also some per user work as well.

Translation:

It’s primarily loss of headcount affecting Azure and not renewals in contracts. It’s also not surprising that Microsoft is prioritizing optimization as the recent keynote at Ignite was about “Do More with Less.” We actually covered this early-on in this analysis here where we stated “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 Making Headway with AI:

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. Here are some comments on the call:

“In Azure machine learning, provides industry-leading ML apps, helping organizations like 3M deploy, manage and govern models. All up, Azure ML revenue has increased more than 100% for four quarters in a row.”

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.

DALL-E is a “12-billion parameter” version of GPT-3 that creates images from text. The partnership with Microsoft will bring DALL-E to apps and services, including the Designer app and Image Creator tool in Bing and Microsoft Edge – this was announced earlier this month at Ignite. According to TechCrunch, 1.5 million users were using DALL-E 2 to create images with brands such as Nestle and Heinz piloting DALL-E for ad campaigns.

Here is what was said on the call:

Mark Murphy

Yes. Thank you, very much. Satya, this quarter, we're seeing an inflection in many of your AI breakthroughs, thinking of GitHub Copilot and the image generation in your designer product. What is it that's enabling you to innovate so rapidly and essentially to be first to market? I'm wondering if it’s the OpenAI relationship or maybe some of your inferencing capabilities or something else?

Satya Nadella:

“Thanks for the question. First, yes, the OpenAI partnership is a very critical partnership for us. Perhaps, it's sort of important to call out that we built the supercomputing capability inside of Azure, which is highly differentiated, the way computing the network, in particular, come together in order to support these large-scale training of these platform models or foundation models has been very critical.

That's what's driven, in fact, the progress OpenAI has been making. And of course, we then productized it as part of Azure OpenAI services. And that's what you're seeing both being used by our own first-party applications, whether it's the GitHub Copilot or Design even inside match […] The AI comment clearly has arrived. And it's going to be part of every product, whether it's, in fact, you mentioned Power Platform, because that's another area we are innovating in terms of corporate all of these AI models. So, yes, so I think AI is a place where I think we have differentiated capability at an infrastructure layer for training and inference and the model that sells or platforms for third parties and our first-party applications are getting better because of the use of those AI models.”

Side note: I know it’s hard to be excited about innovation right now but I do believe Big Tech’s AI fortresses will be built during a recession when other companies are comparatively weaker.

Microsoft Stock: Azure Growth Proves Resilient

Posted on August 15, 2022June 30, 2026 by io-fund

This article was originally published on Forbes on Aug 8, 2022,11:06am EDT

Most investors agree that cloud is a critical trend to have in a portfolio as the category’s growth has been resilient due to increasing productivity while reducing 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 makes sense for startups to rent servers as they don’t have the budget to own servers and manage an IT department. However, despite the many advantages that cloud offers, it requires scaling through outside vendors, which can result in a hit to margins. A report came out that repatriation, or moving some workloads back to on-premise, has resulted in quite a bit of cost savings for companies like Dropbox and Zscaler, who use hybrid approaches. One example in the report is Dropbox, a company that reported savings of $75 million in two years after repatriation, which in turn, helped the company’s gross margins increase from 33% to 67%.

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 the fiscal Q3 call in April: “More value for less price means you win.”

The company’s recent results prove that the company is able to better withstand the challenges of the macro uncertainty better than other cloud peers.

For example, Azure & other cloud services revenue grew by 40% and 46% in constant currency. As stated, Azure’s growth was a major highlight considering Google Cloud’s revenue in the recent quarter increased 36% YoY to $6.3 billion. Notably, GCP is on a lower revenue base which makes Microsoft’s outsized growth even more impressive. The market leader Amazon Web Services revenue grew by 33% YoY to $19.7 billion in Q2.

Here’s how the major cloud IaaS competitors compare:

Cloud Services Market Share – I/O FUND

Furthermore, Microsoft’s Fortune 500 penetration is staggering with 95% using Azure. This 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. We covered Microsoft’s competitive edge on hybrid dating back to 2018 when Azure was frequently doubted by the market as it was overshadowed at the time by AWS.

Today, Microsoft is leveraging its lead in hybrid by undercutting other services on price in order to win the aggregate, long-term contract. By owning the entire cloud stack, Microsoft can offer the ultimate differentiator during macro headwinds, which is “more value for less price” whereas competitors do not own enough of the stack to undercut on price quite like Microsoft.

We originally covered this for our research customers in both our Q2 webinar and a research note last April.

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Microsoft’s Financials:

Microsoft’s revenue grew by 12% YoY to $51.9 billion for the Q4 FY2022 ending in June, and for the FY2022 ending in June, it grew by 18% YoY to $198.3 billion.

The company’s strong guidance for the full year was a testimony to the management's confidence as many of its tech peers failed to give guidance. Amy Hood, CFO of the company said in the earnings call, “We continue to expect double-digit revenue and operating income growth in both constant currency and U.S. dollars. Revenue growth will be driven by continued momentum in our commercial business and a focus on share gains across our portfolio.”

Notably, Microsoft’s stock has outperformed the market with returns of 290% in the last five fiscal years from 08/01/2017 to 07/31/2022. The stock has the second highest returns among the FAAMG stocks, behind Apple which is up 330% during this period.

Microsoft’s stock has outperformed the market with returns of 290% in the last five fiscal years from 08/01/2017 to 07/31/2022. – YCHARTS

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Microsoft’s Revenue Segments:

The company reports its revenues in three segments.

Productivity and Business Processes Segment:

The Productivity and Business Processes segment revenue grew by 13% YoY to $16.6 billion, which includes Office Commercial, Office Consumer, Dynamics, and LinkedIn. LinkedIN came in at 24% growth yet this was lower than the management’s expectation due to a slowdown in advertising revenue. According to management, Teams continues to “take share across every category” and is “seeing higher usage intensity.”

The operating income of this segment increased by 12% YoY to $7.2 billion. The segment accounts for 32% of the total revenue and 35% of the group’s total operating income. The management expects the Productivity and Business Processes segment revenue to be $16.1 billion at the mid-point of the guidance in the next quarter for a slight decline sequentially.

Intelligent Cloud Segment:

The Intelligent Cloud segment revenue grew by 20% YoY to $20.9 billion. The management’s guidance was $21.05 billion, the negative impact from the strong dollar led to the slight miss in this segment. The server products and cloud services revenue grew by 22%, helped by Azure & other cloud services growth of 40%. On a constant currency basis, Azure grew by 46% and the management is guiding for a growth of 43% (constant currency) in the next quarter.

The company also saw strong commitments from its customers as it witnessed a record number of over $100 million Azure and $1 billion deals this quarter. This has a flywheel effect for Microsoft’s data solutions and platforms, as well. Satya Nadella said in the earnings call, “More than 65% of the Fortune 1000 use 3 or more of our data solutions, and we are growing faster than the market.” Cosmos DB data volumes and transactions grew over 100% YoY for the fourth consecutive quarter.

This segment’s operating income increased by 11% YoY to $8.7 billion. The segment accounts for 40% of the Microsoft’s total revenue and 42% of the total operating income.

Intelligent Cloud revenue is expected to be $20.45 billion in the next quarter, or essentially flat sequentially.

More Personal Computing Segment:

The More Personal Computing revenue grew by 2% YoY to $14.4 billion. It was below the management’s guidance of $14.69 billion. The slowdown in this segment was expected since there is weakness in the PC business. Tracking the recent IDC preliminary results suggest that global traditional PC shipments fell 15% in Q2 2022, and the company results were good taking into consideration the macro numbers. Amy Hood said in the earnings call, “Despite the deteriorating PC market, we saw share gains again this quarter and volumes remained above pre-pandemic levels.”

The management expects More Personal Computing revenue to be $13.2 billion in the next quarter, which will be lower sequentially.

Microsoft Flexes Its Muscle on Margins

Microsoft flexed its muscle on margins during a time when many companies are stumbling on the bottom line. This was especially evidenced by Microsoft announcing an accounting change to the life of its servers to offset FX headwinds. We detail this in the section below.

The company’s gross profits increased 10% YoY to $35.4 billion. The gross margin was 68.3% compared to 69.7% in the same period last year. Excluding the impact of the change in the accounting estimate, the gross margin was relatively unchanged.

The operating margin was 39.6% compared to 41.4% in the same period last year. Excluding the impact of the change in the accounting estimate and FX, the operating margin would be relatively unchanged.

The net income was $16.7 billion or $2.23 per share compared to $16.5 billion or $2.17 per share. The strong US dollar negatively impacted revenue by $595 million and EPS by $0.04 in the recent quarter.

The company’s cash flows continued to be strong in the recent quarter. Cash from operations grew by 8% YoY to $24.6 billion (47% of revenue) and free cash flow increased by 9% YoY to $17.8 billion (34% of revenue).

The company has cash and investments of $104.8 billion and a debt of $49.8 billion. The company returned 12.4 billion to the shareholders in the form of share repurchases and dividends in Q4 FY2022, up 19% YoY, and the company spent a similar amount in Q3 FY2022.

FX Headwinds Expected to Ease in 2023

The management expects Q1 FY2023 revenue to grow 10% YoY at the mid-point of the guidance to $49.75 billion. They expect FX headwinds to be higher in the first half of the fiscal year when compared to the second half. For the full year, they expect double-digit revenue and operating income growth. The management expects to complete the acquisition of Activision Blizzard by the end of this fiscal-year and the guidance excludes the impact from the acquisition.

The company also made an accounting change in the useful life for server and network equipment assets from four to six years which will extend the depreciation expenses for the company. This will have an immediate benefit to the company’s bottom line. Amy Hood said in the earnings call, “First, effective at the start of FY '23, we are extending the depreciable useful life for server and network equipment assets in our cloud infrastructure from 4 to 6 years, which will apply to the asset balances on our balance sheet as of June 30, 2022, as well as future asset purchases.

As a result, based on the outstanding balances as of June 30, we expect fiscal year '23 operating income to be favorably impacted by approximately $3.7 billion for the full fiscal year and approximately $1.1 billion in the first quarter.”

On the other hand, Apple did not give the exact revenue guidance for the next quarter. The company’s CFO said in the earnings call, “Given the continued uncertainty around the world in the near term, we are not providing revenue guidance but we are sharing some directional insights based on the assumption that the macroeconomic outlook and COVID-related impacts to our business do not worsen from what we are projecting today for the current quarter.

Overall, we believe our year-over-year revenue growth will accelerate during the September quarter compared to the June quarter despite approximately 600 basis points of negative year-over-year impact from foreign exchange.”

Similarly, Meta Platforms guided revenue of $26 billion to $28.5 billion, or a YoY decline of 6% at the mid-point of the guidance. The guidance considers the weak advertising demand the company experienced in the recent quarter and the foreign exchange headwinds of 6%. Meta’s guidance disappointed investors as they were expecting a return of growth in the next quarter after the revenue declined for the first time in Q2.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Big Tech Earnings: Microsoft And Alphabet Signal Q2 Could Be A Bottom

Posted on August 3, 2022June 30, 2026 by io-fund

This article was originally published on Forbes on Jul 29, 2022,11:24am EDTForbes on Jul 29, 2022,11:24am EDT

Big Tech earnings were off to a solid start last week when Microsoft and Google reported stable revenue growth and margins that are unchanged from recent macro conditions. The strong margins were especially welcomed as many companies have been missing on operating margins and cash flow. Meanwhile, Microsoft delivered free cash flow of $17.8 billion and net profits of $16.7 billion along with upbeat guidance for the year. Similarly, Google reported strong free cash flow of $12.6 billion and net profits of $16 billion in the recent quarter.

The same was not true for Meta, which primarily stumbled on its Q3 guide. The company reported its first decline in revenue in company history and guidance for next quarter missed due to FX headwinds. Analyst expectations for Q3 were for $30.4 billion, or 5% growth. Instead, the company guided for $26 billion to $28.5 billion, or a YoY decline of 6% at the mid-point of the guidance with the current exchange rates creating a 6% headwind.

Alphabet: Search is Resilient

The company reported revenue of 13%, or 16% in constant currency, for a total of $69.7 billion. The operating margin was flat year-over-year, which is a win. Operating expenses grew 24% yet the operating margin was in line with previous quarters at 28% for $19.58 billion in operating income.

The net margin was a bit weaker than previous quarters in 2021 at $16 billion yet in line with last quarter. The company has free cash flow of $12.6 billion. The company has $125 billion in cash and marketable securities. The company reported EPS of $1.21 compared to $1.36 for the same period last year.

Search was stable given the current environment at 13.5% growth to $40 billion and this provided relief that not all ad spend has been paused. Search was strong last quarter at 24% growth to $40 billion, and was flat sequentially in terms of total dollar amount.

The effects of Google’s large R&D department and advances in AI cannot be overstated when it comes to the resiliency of Search in the current environment. We are getting a very slight glimpse of what’s to come for Google in terms of its advertising dominance.

The expectations were that YouTube would weigh on the report yet YouTube provided a bit of growth at 5% year-over-year. The company was adamant that YouTube growth is low because of the tough comps. The tough comps was touched on many times, such as this: “the modest year-on-year growth rate primarily reflects lapping the uniquely strong performance in the second quarter of 2021.”

Notably, Google Cloud slowed to 35.6% growth down from 43.8% growth last quarter. This means Google Cloud is growing slower than Azure on a lower revenue base. This is something to monitor in the future.

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Microsoft: Double-Digit Guide for FY2023

Many tech companies are declining to give guidance while Microsoft’s management provided strong guidance in both Q1 FY2023 and for FY2023. For Q1 FY2023, management provided a 10% guide across product lines for next quarter (this includes FX headwinds) and also provided guidance for fiscal year 2023 ending in June: “We continue to expect double-digit revenue and operating income growth in both constant currency and U.S. dollars. Revenue growth will be driven by continued momentum in our commercial business and a focus on share gains across our portfolio.”

Revenue grew by 12% YoY to $51.9 billion (missed Wall Street analysts' estimates by 0.94%) and EPS came at $2.23 (missed estimates by 2.9%). The strong US dollar negatively impacted the revenue by $595 million and EPS by $0.04. Microsoft Cloud revenue grew by 28% YoY to $25 billion. The company’s results are good considering the various macro uncertainties, China lockdown, and the strong US dollar. FY2022 revenue grew by 18% YoY to $198.3 billion and net income increased by 19% YoY to $72.7 billion.

The company’s gross profits increased 10% YoY to $35.4 billion. The gross margin was 68.3% when compared to 69.7% in the same period last year. Excluding the impact from the change in the accounting estimate, the gross margin was relatively unchanged.

The operating income increased by 8% YoY to $20.5 billion. The operating margin was 39.6% compared to 41.4% in the same period last year. Excluding the impact from the change in the accounting estimate and FX, the operating margin would be relatively unchanged.

Despite weakness in PCs, the company’s other segments continue to grow. Intelligent Cloud grew 20% YoY to $20.9 billion and Productivity and Business Processes segment grew 13% YoY to $16.6 billion.

The company also made an accounting change in the useful life for server and network equipment assets from four to six years which will extend the depreciation expenses for the company.

Amy Hood said in the earnings call, “First, effective at the start of FY '23, we are extending the depreciable useful life for server and network equipment assets in our cloud infrastructure from 4 to 6 years, which will apply to the asset balances on our balance sheet as of June 30, 2022, as well as future asset purchases.

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Meta: Misses Q3 Expectations

The market does not need a perfect quarter for Q2 given the numerous headwinds facing tech companies. What the market does need is a sign that a company may have bottomed and is able to guide growth (even if minimal) from Q2-Q3.

In Q2, Meta’s revenue declined for the first time in history. This was expected. However, what was not expected was the lower guide for the next quarter. The company guided for $26 billion to $28.5 billion, or a YoY decline of 6% at the mid-point of the guidance. The guidance takes into consideration the weak advertising demand the company experienced in the recent quarter and also the foreign exchange headwinds of 6%. The investors were expecting a return of growth in the next quarter.

The company had a slight beat on DAUs at 1.97 billion versus 1.96 billion expected. Monthly users were 2.93 billion slightly missed expectations of 2.94 billion.

Total expenses rose 22% YoY to $20.4 billion. This led to the drop in the operating margin to 29% in the recent quarter compared to 43% in the same period last year. It also led to the 36% YoY drop in the net income to $6.69 billion. The EPS came at $2.46 compared to $3.61 in Q2 2021.

The company is looking to further reduce the total expenses for the year to $85 billion to $88 billion from the last quarter guidance of $87 billion to $92 billion and the prior estimate of $90 billion to $95 billion.

We discussed why Meta is likely to continue to face headwinds in an in-depth webinar here:

Apple: Strong results despite challenges

Apple released strong results despite the challenging macro environment, strong US dollar, and supply chain issues. Revenue grew by 1.9% YoY to $83 billion, which was in-line with the analysts' estimates. It reported EPS of $1.20, which beat estimates by $0.04 (4% beat).

The product segment revenue declined marginally by 0.9% YoY to $63.4 billion and the services segment revenue grew by 12% YoY to $19.6 billion. The company’s installed base of active devices reached an all-time high. It had more than 860 million of paid subscriptions, up 160 million in the past year.

The company did not give exact revenue guidance for the next quarter. Tim Cook, CEO of the company, said in the earnings call, “We’re going to accelerate revenues in the September quarter as compared to the June quarter and will decelerate on the Services side.”

The company’s gross margin was 43.26%, compared to 43.75% in the previous quarter and 43.29% in the same period last year. It was above the management’s guidance of 42% to 43%.

Net income was $19.4 billion or $1.20 per share compared to $21.7 billion or $1.30 per share in the same period last year. It beat the analysts' EPS estimates by $0.04.

The company had cash and marketable securities of $179 billion and a debt of $120 billion. The company reported strong operating cash flows of $23 billion (28% of revenue). The company returned over $28 billion to the shareholders in the recent quarter in the form of dividends and share repurchases.

Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.

Alphabet Q2 2022 Earnings: Search’s Strength is Underrated

Posted on July 27, 2022June 30, 2026 by io-fund

Google and Microsoft both flexed their muscle in terms of margins with nearly no impact over the past few quarters due to the macro headwinds. The quarter was stable in terms of both revenue and margins.

There’s a chance the market is sniffing out that Q2 could be a bottom for financials. We need more information (this is not a statement written in stone) but there is evidence that some companies may have bottomed – Netflix’s return to (minimal sub growth), Tesla’s H2 deliveries guide, and Microsoft is a double-digit growth guide for FY2023 while predicting FX headwinds will ease between January-June.

I believe Google’s rally is due to the company’s category leading strength in ads, specifically Google Search, and the prospects of what it will look like when YouTube bounces back. Due to lack of guidance, we don’t have any hints on whether Google bottomed or not, but comparatively the company is stronger than expected.

You can watch my Bloomberg appearance here where I discussed this point Tuesday evening.

Alphabet Q2 2022 Earnings:

We covered the strength of search in our analysis: Alphabet is our Second FAANG.

“The strength in Search highlights the advantage that having first-party data provides. This is because Search is primarily done on a browser, allowing Google to capture valuable first party data from ownership of Google Chrome, Google Search and also from Android OS. Moreover, Google is releasing new products, such as Topics API, which enables behavioral targeting. This is a direct shot at Meta Platforms, who is known to be quite competitive on behavioral targeting through taxonomies.”

On the call, an analyst asked what is the company’s north star, given their margins are very strong. Later, the CEO discussed that his focus is using their cash to drive more R&D in AI, which flows through to Google Search and YouTube, which then generates more cash to drive more R&D, etc.

“So, for example, we are obviously investing deeply in AI. We do everything from pure research to applied research to research, which is now things AI work, which is actually happening very close or within the areas like Search and YouTube, et cetera.

And so, you can imagine a scenario in which we are prioritizing and on the margin moving resources to making sure we are driving product improvements, which flow through a moment like that. That would be an example of sharpening focus for me.

And when I think about the opportunities out of AI, just coming out of I/O this year, looking at the progress we have made, how much we have made progress with multisearch, how multimodal things are getting and the fact that people are now actually doing voice searches a lot, visual searches a lot, all that is a good example of how we are driving value in our core products.”

The other issue is that just like hiring is seeing a reversion to 2019 levels, so is ad spend. The levels of ad spend seen in 2020-2021 are not sustainable which is why we are reverting back to 2019 in many of these growth rates. Regardless, the overall tone was positive about YouTube especially as YouTube shorts alone now has 1.5 billion signed-in users per month and 30 billion daily views.

Retail was discussed on the call. Although the management team declined to be granular with analysts, they did feel their products are better positioned to serve retail, as evidenced by the current growth rates compared to competitors, due to Omnichannel. Retailers prefer to drive both offline and online sales through multiple channels for in-store, online, curbside pickup which Google helps with across Search both mobile and browser, YouTube, and location-based searches/maps. Google introduced a new way to buy ads across all of Google’s channels called Performance Max with a single campaign to help more retailers tap into omnichannel.

We discussed in our recent Q3 webinar the importance of Big Tech capex, especially for semiconductor investors. This will be something to closely monitor in Q1 reports of next year in terms of expected capex.

So far, so good for this quarter. We got the following from Ruth Porat, CFO:

“Turning to CapEx. The largest investments in the second quarter were in servers followed by data centers and office facilities. After several large transactions closed in the first quarter, investment in office facilities was once again focused on fit-outs and ground-up construction on existing projects. We continue to expect an increase in CapEx in 2022 versus last year. For the balance of 2022, the increase will be particularly reflected in investments in technical infrastructure globally with servers as the largest component.”

Google Cloud slowed to 35.6% growth down from 43.8% growth last quarter. This means Google Cloud is growing slower than Azure on a lower revenue base. This is something to monitor in the future.

The company announced $70 billion in buybacks last quarter which is up from $50 billion in the previous year. This is also a marked increase from 2019 which saw $25 billion in buybacks.

Conclusion:

We had said this the following in our last write-up which pulls the pieces together to answer why Google has demonstrated stability in the face of ad-tech headwinds:

“Google also reiterated this point during their Q1 Conference Call when CBO Philipp Schindler explained that being able to fully measure what users do after they click on an ad is critical to measuring ROI. He added that “Measurement is also obviously a key component to success [in CTV], and we want to make sure that advertisers can fully measure their YouTube CTV video investments across YouTube and YouTube TV for an accurate view of true incremental reach and frequency and so on.”

CBO Schindler’s comments highlight the importance of measurement, a key aspect of digital advertising that has been challenged following the changes to iOS cookies. If advertisers cannot measure ROI, they tend to limit their ad expenditures, so it's critical that ad platforms find solutions to measure ROI in order to sustain growth.”

Ultimately, in addition to Google’s many channels, Google is resilient right now due to AI driving stronger ROI for advertisers. For example, AI-powered Performance Max has grown 5X year-to-date with case studies driving 60% more revenue.

The company is also more defensible following Apple’s attribution and measurement changes as the Google can provide this on their OS and browser while offering an omnichannel strategy.

Microsoft Earnings Review Q4 FY2022

Posted on July 27, 2022June 30, 2026 by io-fund

Microsoft released its Q4 FY2022 results for the period ending June 30th. Revenue grew by 12% YoY to $51.9 billion (missed Wall Street analysts' estimates by 0.94%) and EPS came at $2.23 (missed estimates by 2.9%). The strong US dollar negatively impacted the revenue by $595 million and EPS by $0.04. Net income grew by 2% YoY to $16.7 billion. Microsoft Cloud revenue grew by 28% YoY to $25 billion. The company’s results are good considering the various macro uncertainties, China lockdown, and the strong US dollar. FY2022 revenue grew by 18% YoY to $198.3 billion and net income increased by 19% YoY to $72.7 billion.

The company’s CEO Satya Nadella sounded more confident about the company’s prospects. He said, “In this environment, we are focused on 3 things: first, no company is better positioned than Microsoft to help organizations deliver on their digital imperative so that they can do more with less. From infrastructure and data to business applications and hybrid work, we provide unique differentiated value to our customers. Second, we will invest to take share and build new businesses in categories where we have long-term structural advantage. Lastly, we will manage through this period with an intense focus on prioritization and executional excellence in our own operations to drive operational leverage.”

The company’s gross income increased 10% YoY to $35.4 billion. The gross margin was 68.3% when compared to 69.7% in the same period last year. Excluding the impact from the change in the accounting estimate, the gross margin was relatively unchanged.

Segment results:

The Productivity and Business Processes revenue grew by 13% YoY to $16.6 billion. This was in line with the midpoint of the management’s guidance given in June. The Office Commercial revenue grew by 9% and Office 365 commercial revenue grew by 15%. Dynamics revenue grew by 19%, which was helped by Dynamics 365 growth of 31%. It was slightly below the management’s growth expectation. LinkedIn revenue increased by 26%, which was lower than the management’s expectation due to the slowdown in advertising revenues.

The Intelligent Cloud segment revenue grew by 20% YoY to $20.9 billion. The management’s guidance was $21.05 billion, the negative impact from the strong dollar led to the slight miss in this segment. The server products and cloud services revenue grew by 22% helped by Azure & other cloud services growth of 40%. On a constant currency basis, Azure grew by 46% and the management is guiding for a growth of 43% in the next quarter. Google Cloud revenue in the recent quarter grew by 36% YoY to $6.3 billion.

Some of the key wins in the recent quarter include American Airlines that chose the company’s cloud platform to run its operations. Telecommunications company, Telstra will use Microsoft Azure for its internal IT workloads. The operating income increased by 11% YoY to $8.7 billion. The segment accounts for 40% of the group’s total revenue and 42% of the total operating income. Intelligent Cloud revenue is expected to be $20.45 billion in the next quarter.

The More Personal Computing revenue grew by 2% YoY to $14.4 billion. It was below the management’s guidance of $14.69 billion. The slowdown in this segment was expected since there is weakness in the PC business. Windows OEM revenue fell 2% and despite the deteriorating PC market the company witnessed some share gains. Surface revenue grew by 10%, which was helped by commercial sales. The gaming revenue declined 7% and was in line with the management’s expectations. The operating income fell by 5% to $4.6 billion. The segment accounts for 28% of the total revenue and 22% of the operating income. The management expects More Personal Computing revenue to be $13.2 billion.

Guidance

The management expects Q1 FY2023 revenue to grow 9.8% YoY at the mid-point of the guidance to $49.75 billion. The strong dollar and PC weakness might be the reason for the company to give a cautious guidance for the next quarter that was lower than the analysts' initial estimates. They expect FX headwinds to be higher in the first half of the fiscal year when compared to the second half.

They sound more optimistic on the full year guidance as they expect revenue to grow double digits for the full year. Amy Hood, CFO of the company said in the earnings call, “We continue to expect double-digit revenue and operating income growth in both constant currency and U.S. dollars.” The management guidance does not take into consideration the impact from the acquisition of Activision Blizzard which they expect to complete by the end of the fiscal year 2023.

The company also made an accounting change in the useful life for server and network equipment assets from four to six years which will extend the depreciation expenses for the company. Amy Hood said in the earnings call, “First, effective at the start of FY '23, we are extending the depreciable useful life for server and network equipment assets in our cloud infrastructure from 4 to 6 years, which will apply to the asset balances on our balance sheet as of June 30, 2022, as well as future asset purchases.

Conclusion

Microsoft is in a better position to withstand the macro challenges with stable revenue, consistent margins and the company’s strength in Microsoft Cloud. The company’s forward guidance for the next fiscal year looks positive. Despite PC’s weakness, the company’s other segments continue to grow. Notably, Microsoft Azure’s growth is very solid and outpaced Google Cloud.

Hybrid Work Is Here To Stay And Asana Will Be A Key Beneficiary

Posted on December 22, 2021June 30, 2026 by io-fund

Hybrid Work Is Here To Stay And Asana Will Be A Key Beneficiary

December 17, 2021, 11:47am EST (originally published on Forbesoriginally published on Forbes)

Hybrid and work from home environments are a fundamental tailwind for cloud-based tools that help facilitate this key micro trend. Due to the inherent benefits of hybrid/remote environments, such as decreased fixed expenses (rent) and increased access to global talent, along with the necessary infrastructure in place from the rise of cloud computing, this trend will gain momentum going forward.

Asana is one of the key cloud-based tools that facilitates efficient hybrid work environments and stands to benefit from the structural shift underway that is transforming how people work. Asana is a work management platform that helps teams orchestrate work across an entire enterprise, connecting teams around the globe in an easy-to-use platform. The thesis is fairly easy: do you think workers will go back to being in-office full-time? If not, then more cloud-based tools will be required to perform work efficiently. Notably, these tools were already rising in popularity prior to Covid based on the efficiency factor alone.

Customers use Asana to improve team collaboration and workflow management, helping teams track their progress on projects, assign tasks and responsibilities to employees, set deadlines and keep a record of data related to their work. The company was founded in 2008 by Facebook executives Dustin Moskovitz (co-founder of Facebook) and Justin Rosenstein in 2008.

The two had worked together at Facebook and experienced firsthand the coordination challenges the company faced as it rapidly scaled its business. The two realized that they were spending a significant amount of time trying to figure out who was responsible for what, essentially creating ‘work about work’. This unproductive bottleneck inspired them to create a product that would help organizations coordinate their work.

One of the company’s main focuses has been to increase employee productivity by helping them focus on priority tasks and avoid distractions. Asana has been used by a wide range of companies for multiple uses, such as product launches and marketing campaigns. It helps its users know in real-time what each member of the team is working on and allows managers to easily check project progress to ensure that tasks are completed successfully and on time.

With the rise of remote work environments, Asana’s solutions have experienced rapid growth and demand for its solutions has been especially strong with enterprise customers. Asana went public via a direct listing in September 2020 and the company’s stock is up about 135% since its listing and had gains of about 390% during its peak a month back. Despite the recent pullback in Asana’s stock price, the company remains well positioned to continue to gain share in the rapidly growing work management market (i.e., same story a month ago at a discounted price).

Hybrid-work-from-home will be the future working environment for many organizations, with 73% of employees wanting a flexible remote work option. I am bullish on this micro trend and believe that companies in this space will continue to grow going forward. Asana is a beneficiary of hybrid work environments, evident in its exceptional strong revenue growth, which recently accelerated to 70% in the most recent quarter. The I/O Fund noticed Asana’s rapid growth earlier this year and took a position, realizing an 85% gain in under a month.

Asana, at the time, was quite undervalued based on their expected growth, so we initiated our 1st buy in February at $40. We decided to ride the volatility in Asana in March, and instead looked for breakout, which manifested in May when we added again at $33.25. We became fully allocated in Asana on May 20th, and set our targets above. We trimmed this position 3 times, locking in gains between 65%, 115%, and 224%. We closed the position on November 8th for a 285% gain. Recently, we started accumulating again in the $70s and again in the $60s.

We still like Asana at the I/O Fund, however it’s a position we decided to actively manage rather than buy-and-hold. It could turn into a buy-and-hold but for now requires a more active stance. In the article that follows, I discuss Asana’s market opportunity, product roadmap, financial performance, competitive landscape, and key risks that investors should be aware of.

Market opportunity

The company operates in a large market that is rapidly expanding. According to Allied Market Research, the team collaboration market size is expected to grow at a compounded annual growth rate of 13% for the next decade and reach a total addressable market of $27 billion by 2027. Furthermore, Grand View Research estimated that the global productivity management software market was $43 billion in 2020 and is expected to grow at a CAGR of 14% from 2021 to 2028. In Asana’s recent presentation, they estimate that their total addressable market for workplace solutions will be nearly $51 billion by 2025.

To give a sense of the large market opportunity in front of the company, a recent Forrester Research report estimates that there are about 1.25 billion information workers that would benefit from using Asana’s solutions. The company believes that it is still in the early innings of its the market opportunity and estimates that its market penetration is less than 3% of its addressable population of information workers. Looking forward, there is ample room for Asana’s topline to continue to expand as more information workers take advantage of work management solutions.

Product Roadmap

The company’s platform is built on its proprietary, multi-dimensional data model that it calls the Asana Work Graph. It has features like boards that allow users to easily create tasks for the team, view what other team members are working on, and create different views like calendar list views. Furthermore, the timeline feature allows decision makers to quickly learn the status of a task, who is responsible for executing the work, and helps reduce redundancies.

There are also reporting tools that provide key information about work, such as files, comments and metadata. The result is that Asana helps teams collaborate across an entire organization and ensures that projects are completed on time and efficiently. Asana’s benefits compound in large, complex hybrid work environments such as large enterprises, which I touch on in more detail below.

Another key advantage of the Asana platform is that it has integration capabilities with major apps, such as Microsoft Teams, Okta and Dropbox. These integrations and partnerships with other cloud-based tools help further facilitate the transition to hybrid work environments and improve efficiencies.

With the rising number of information workers who are increasingly working remotely, Asana’s products help employees coordinate core projects, improve productivity across the enterprise and remove information silos that have historically separated teams across an enterprise. Asana’s solutions also yield a solid return on investment for its customers. According to a study conducted by the IDC, respondents reported that Asana has increased organizational efficiencies by reducing time spent on emails by 33%, improved process execution by 42%, and has yielded a 224% 1-year return on investments for its customers.

Asana has also partnered with numerous technology firms to add more features and functionality to its platform. A standout that management highlighted during the Q2 earnings call was Zoom’s integration within Asana. This unique feature allows Asana customers to create a Zoom meeting while they are performing a task directly inside the Asana platform. Once the Zoom meeting is over, the Zoom recording and the transcript can be added to Asana and tasks discussed during the meeting can be assigned to owners. This functionality improves the efficiencies of meetings and helps reduce the amount of time spent “working on work”.

As mentioned above, work complexity compounds as organizations increase in size and become more dispersed with hybrid work environments. Asana’s Work Graph helps reduce the growing complexity for enterprises and replaces micro-management with macro-management, “by aligning [leaders] around key objectives and the work needed to achieve them no matter where they are in the world” (Q3 Earnings Call). We can see the success that Asana has had reducing hybrid complexities by observing growth trends with large enterprise customers, which have accelerated recently. I discuss this trend and Asana’s financials in more detail next.

Financials

Asana released its Q3 FY2022 results on December 02, 2021, which beat both on the top and bottom-line. Revenue growth accelerated to 70% YoY and quarterly sales were $100 million, which beat analysts’ estimates by $6 million. Revenue has increased sequentially for at least 11 consecutive quarters and Asana now has an annualized topline run rate of over $400 million. The growth was led by strong customer metrics as total paid seats surpassed 2 million and total paying customer increased 28% YoY to 114,000.

However, the real story is Asana’s success with enterprise customers, which generally pay more and sign longer-term contracts. Because of this, enterprise customers are generally the most valuable type of customers for a software provider. Asana’s success with this cohort speaks to the overall value that its workplace solutions provide.

For example, while total paying customers increased 28% YoY to 114,000, customers spending $50,000 or more per year (enterprise customers) grew by 132% YoY to 739. This represented an acceleration from the 111% and 92% YoY growth rate in enterprise customer count in Q2 and Q1 FY2022, respectively. The accelerating growth in enterprise customer count highlights the benefits that Asana provides to large, complex hybrid environments. Further highlighting this strength, Asana’s dollar-based net retention ratio for enterprise customers was 145%, up from 140% in the prior Q3 period and exemplifying that enterprise customers are expanding their usage of Asana overtime, a sign of strength.

Some of the large key customer wins in the quarter included Warner Music Group, which chose the company’s enterprise solutions “to organize, manage and track the end-to-end process of how they identify, evaluate and bring new artists into its various labels faster and more effectively”. Asana also expanded its deal with a Japanese customer, which is one of the largest automotive manufacturing companies in the world. Management explained that the Japanese auto customer’s expanded agreement was to help manage their software and product developments (Q3 2021 Conference Call). These customer wins highlight that Asana is useful across multiple industries and different geographies.

It is noteworthy that while Asana is growing its enterprise customer base, it is doing so on a global scale. This provides support that Asana is still early in its topline run rate and has amble room to expand both domestically and globally. Furthermore, Asana is preparing for global growth as it recently expanded its support to 13 different languages, which will help the company capture customers is numerous markets around the world.

Looking forward, Asana expects Q4 revenue to be in the range of $105 million to $106 million, representing a 53% to 54% YoY growth rate. While this represents a deceleration from recent growth rates, the company is likely being conservative with their topline guide. For instance, management guided Q3 sales to grow 59% YoY (at the mid-point) and actual Q3 sales growth came in at 70% YoY.

Management also expects Q4 adjusted operating loss of $53 million to $51 million and adjusted net loss per share of ($0.28) to ($0.27). This represents a larger loss than the Q3 adjusted operating loss of $41 million and adjusted loss per share of ($0.23). While the guide for larger losses is somewhat concerning, the company is investing to grow rapidly to capture market share in the large, untapped work productivity market. As a result, Asana is front-loading investments today that will pay dividends in the future.

We can see the front-loading of expenses by observing trends in sales and marketing (S&M) expense. As shown below, the company’s S&M expense increased as a percentage of total revenues to 73%, which was up 200 bps QoQ but down 900 bps YoY. Asana’s COO Anne Raimondi explained on the Q2 call that the company has been ramping hiring to support international expansion. Specifically, she stated that the company has been “increasing sales and marketing capacity across all of these new offices and regions. So, lots of hiring to support our customers”. Ultimately, I am not concerned with the rise of S&M expense margin since the company is investing in its future growth, which will help the company quickly scale its operations, improving both earnings and cashflows in the long run.

Moving to cashflows, quarterly free cash flow was -$30 million as of Q3 FY2022, down YoY from -$20 million for the same period last year. However, YTD free cash flow -$46 million, an improvement from the prior year metric of -$58 million. Cashflows can be lumpy, but as enterprise customers continue to increase as a percentage of total sales, their recurring upfront cash payments will lead to improving cashflows overtime.

Stock-based compensation and insider purchases

It is also noteworthy that Asana pays some of its salaries with stock-based compensation (SBC), which cosmetically improves the presentation of cashflows. For instance, in the latest quarter, Asana issued $26 million in SBC, up from $9 million in the prior year quarter. However, quarterly free cashflow improved $18 million YoY, or $1 million absent the benefit from increased stock-based compensation. The increase in free cashflow after adjusting for the rise in SBC highlights that Asana has been able to leverage its scale to a degree. Nonetheless, cashflows will remain lumpy going forward and SBC growth may outpace free cashflow generation in the near term.

A benefit of rising SBC is that it makes employees owners in the business, giving them a vested interest in the company’s success. This in turn should improve employee retention and lower turnover, which will help Asana better scale its operations as seasoned employees are generally more efficient than new hires.

Management has also been purchasing shares, which can be a sign that management believes that the company is undervalued. For instance, board member Lorrie Norrington recently purchased 3,733 shares on December 6th for a total purchase value of $248,000 (~$66.51/share). This was the second time she had purchased shares this year after spending $199,000 for 6,200 shares in March 2021(~$32.12/share). Ms. Norrington’s purchases follow a drop in Asana’s price following the general tech sell off that occurred in the back half of 2021. Given the company’s continued strength with enterprise customers discussed above, Asana may be at a decent risk/reward right now.

Another insider that has been purchasing shares is CEO-founder Dustin Moskovitz. CEO Moskovitz has purchased over 6 million shares year to date, which is generally a very bullish signal. However, the purchases likely relate to the redemption of a convertible bond that CEO Moskovitz holds in a trust. As disclosed in Asana’s 10Q, the company elected to convert a convertible note that was “held by a trust affiliated with Mr. Moskovitz and the shares were accordingly issued to the trust. The conversion of the Convertible Notes therefore increased Mr. Moskovitz’s voting power”. Nonetheless, the increase in CEO Moskovitz ownership further aligns his incentives with shareholders, which is generally a positive development.

Competition and why Asana is winning

The work management platform space is very competitive and there are numerous public and private companies competing with Asana. Asana’s main publicly traded competitors are Atlassian (Jira) and Monday.com, but they also compete with Smartsheet and other private companies such as Airtable. For the sake of brevity, I will only be discussing Monday.com and Atlassian’s Jira offering and what sets Asana apart from these competitors.

One of the key pillars separating Asana from Jira is that Asana is built for all teams within an enterprise, while Jira was specifically designed for software developers. Asana claims that Jira is not flexible enough to be applied to teams across an entire enterprise, while Asana was built to be applicable to all employees within an organization. However, the two are not mutually exclusive and users are able to integrate the Jira cloud within the Asana platform, brining Jira’s software development focus into Asana’s easy to use workflow platform. This integration allows all employees to remain in sync and helps various teams, such as business and software development, collaborate across the organization. To remain competitive, Atlassian bought Trello in 2017.

Possibly Asana’s most direct competitor is Monday.com, which went public in June 2021. The two are the leading providers of workflow solutions and both are growing strongly. Asana differentiates itself by being easy to use, transparent and user friendly, making it accessible to all users in an organization, even the non-technical ones. On the other hand, Monday.com claims that it is a Work Operating System, that is more advanced and customizable.

Without getting into the differences in the platform offerings, the key differentiator between the two is likely price. Given that enterprise customers are important to both of these companies’ success, and that neither company directly discloses enterprise pricing, I relied on enterprise customer metrics to get a sense of which platform is favored by large organizations.

As mentioned above, Asana’s enterprise customers growth recently accelerated from 111% to 132% YoY growth, the fastest pace of YoY growth in FY2022. Similarly, Monday.com also reported an acceleration in enterprise customer growth, as customers with annualized recurring revenue >$50,000 grew 231% YoY, up from the Q2 growth rate of 226% YoY.

While Monday.com is growing enterprise customer’s faster than Asana, Asana’s enterprise growth is accelerating more rapidly. For instance, Asana’s enterprise customer growth accelerated 2,100 bps in the most recent quarter, versus to 500 bps acceleration for Monday.com.

Moreover, Asana had 739 enterprise customers in the latest period, which was 20% higher than Monday’s 613 enterprise customers. However, Monday.com was founded in 2012 while Asana was founded in 2008, so Asana’s head start may be the reason why Asana currently has more enterprise customers.

Unfortunately, neither company directly discloses enterprise pricing, but Asana did announce that they have some seven and eight figure deals, highlighting how not all enterprise contracts are not the same. It is noteworthy that both companies report high gross margins, with Asana reporting a GAAP gross margin of 91%, which is about 300 bps higher than Monday.com’s GAAP gross margin of 88%. Asana’s higher gross margin suggests that it is not sacrificing price to drive sales growth, which can be a sign of competitive strength, especially given its recent acceleration in enterprise growth. However, both companies have very similar metrics and are valued about the same (Asana’s market cap is $13 billion while Monday.com market is $12 billion as of publication).

The market likely needs more time and information to fully understand who the winner will be in the work management platform space. However, recent trends suggest that Asana may be pulling ahead given its rapid acceleration with enterprise customers and higher gross margins. We are still early in Asana’s growth story, and there are plenty of risks ahead of the firm, which I discuss in more detail next.

Risks:

Asana faces significant competition in the fast-growing work management space and it is not yet clear who the winner will be. Furthermore, larger companies could very well enter the space and compete with Asana’s solutions, possibly turning customers into competitors.

Asana has also experienced rising losses as it scales its business. The company’s operating expenses are expected to be high as it invests in human capital and office space to expand its operations globally. There is also no clarity as to when the company will be profitable, and shareholders may be diluted if cashflows do not improve going forward. Furthermore, the company recently reported a deceleration in bookings growth, which may forewarn a broader slowdown in sales in the near term. CFO Tim Wan addressed this concern during the Q3 call and explained that bookings are not a great barometer for growth, due to the large amount of customers still on monthly billing plans. Since monthly customer do not impact deferred revenue, they skew the calculation of bookings. Nevertheless, bookings growth will need to be monitored going forward since it is an important metric for Software-as-a-Service companies.

Conclusion

Looking forward, Asana appears well positioned to continue to capture share in the work management space. Hybrid and remote work environments are a structural tailwind that will drive demand for work management solutions. Furthermore, these tailwinds will likely gain momentum due to the inherent benefits they provide to both employees and employers. Asana recently reported an acceleration in topline growth, and enterprise customer metrics accelerated even faster. While it is not yet clear who the winner will be in the work management space, Asana appears well positioned given its high gross margins and strong customer metrics. Asana has a large addressable market in front of it and its penetration is very low, suggesting that we are still very early in the company’s growth story.

Royston Roche contributed to this article.

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. The I/O Fund has owned Asana stock in the past and currently owns Asana stock at time of writing. There are no plans to change the position in the next 72 hours.

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