Microsoft FQ2 2023 – Cloudy with showers

The inevitable slowdown.

• Microsoft reported good results that were spoilt by a slowdown in the cloud meaning that growth going forward is going to be lower which in turn raises questions over the valuation.
• FQ2 2023 revenues / ADJ-EPS were $52.7bn / $2.32 compared to consensus at $52.9bn / $2.30.
• This represented growth of 7% YoY in constant currency terms and was largely carried by Azure which grew 38% YoY offsetting Office Consumer (down 2% YoY), Windows OEM (down 39% YoY) and devices (down 39% YoY).
• It is now that the real reason for the 10,000 headcount cut becomes clear as Windows OEM is the business that sells Windows licences to PC makers which is hugely profitable and so Microsoft needs to reduce costs to keep profitability at a good level.
• Microsoft is being hit with a double whammy of normalisation of demand from the pandemic as well as the weaker economy but to be fair its outlook against this tough backdrop remains pretty good.
• Microsoft started to see the slowdown in Azure towards the end of 2022 which would make some sense as budget flush carried revenues before the more austere budgeting for 2023 took over.
• Azure is now expected to slow to the 30% YoY range from the mid-30s at the end of 2022 and this will impact the whole company.
• Cloud is still going to be the highest-growing segment of enterprise IT but it just going to be slower than it was last year.
• We are also beginning to arrive at a place where the law of large numbers also begins to impact the Cloud as it is such a large segment now that really high growth rates are simply impossible to maintain.
• This was always going to happen, and it looks like the weaker economic environment is the trigger for the maturation of the cloud computing industry.
• Amazon is also likely to take a hit which is more problematic as AWS has been allowing Amazon to keep its head above water from a profit perspective which may also explain why Amazon is cutting staff harder than anyone else.
• Microsoft says that its customers are optimising their spending and delaying where they can and that there will be a lag before it picks up again.
• In English, this means customers are cutting budgets and Microsoft does not know when they will start growing spending again or even if it will come to Microsoft when it does.
• This is why the company has gone back to the AI-everything mantra as the Metaverse theme is now a pretty unpopular way to market one’s technological competence.
• I think that there is plenty of space within Microsoft’s products for them to be made better by AI, but the scope remains limited.
• Microsoft would have us believe that all of its products will become amazing with a liberal sprinkle of AI, but the reality is that this will only be true for certain things.
• These are tasks where the data set is extremely well defined and doesn’t change but for other things like chatbots, there is very little on the horizon that is going to make them better.
• From personal experience spending 10 hours a day or more with Office products, the AI that is in them already is pretty awful meaning that Office works better with them switched off.
• Hence, there is a lot of scope for improvement but that is going to take time.
• In the meantime, the economic slowdown is going to crimp earnings expansion meaning that EPS might even decline slightly this fiscal year.
• For a company with Microsoft’s valuation, this is not a great proposition for investing and so I would continue to look elsewhere.