Despite revenue miss, Microsoft shares climb on hopes for improved cloud performance

CLOUD

After two straight quarters of disappointing earnings results, investors were heartened by signs that Microsoft Corp.’s cloud business is breaking out of the doldrums, but a weak forecast dulled their initial optimism.

The software and cloud giant reported slightly better than expected revenues in its Intelligent Cloud business on overall revenues that came in barely below analysts’ estimates.

Fiscal second-quarter earnings fell 12% from a year ago, to $16.4 billion, or $2.20 a share. The reported figure included severance, impairment and lease-consolidation costs cost of 12 cents a share, meaning that adjusted earnings were $2.32, or slightly better than the average analyst prediction of $2.29.

Revenue of $52.7 billion fell just short of the $52.9 billion analysts expected and up from $51.7 billion a year ago. Microsoft said its profit declined more than 12% during the holiday season, prompting plans for a layoff of 10,000 employees, or 5% of its workforce, which was announced last week. The total headcount was still up 19% at the end of 2022 compared to a year earlier.

Investors initially cheered the news that Intelligent Cloud revenue of $21.5 billion beat analyst expectations of $21.4 billion. The company’s shares fell sharply last October when it reported that the Azure infrastructure-as-a-service business grew just 35% in the quarter, well below the 50% growth of a year earlier.

Forecasts disappoint

However, the forecasts executives presented on the conference call quickly erased most of the early gains. “We expect the business trends we saw at the end of December to continue into Q3,” said Chief Financial Officer Amy Hood. “We expect bookings to be relatively flat year-over-year.”

Hood said Intelligent Cloud revenue growth is expected to fall to 19% in the next quarter from the 24% just reported. Growth in the Azure business with “decelerate four to five points in constant currency.” Overall revenues are also expected to decelerate in the second half of the year, with operating margins declining by about 1%.

The forecast cut an initial 4% jump in after-hours trading of Microsoft’s stock to a little over 1%. Worries persist about what the layoffs announced last week signal about the overall health of the business during a time of heightened economic uncertainty.

The timing of the company’s announcement yesterday that it would deepen its commitment to machine learning startup OpenAI LLC may have been timed, in part, to assure investors that Microsoft is serious about returning its cloud business to high growth.

“Microsoft’s AI investments have been geared toward simplifying or automating labor-intensive tasks, which could impact the profitability of Azure and other business units,” said Charles King, chief analyst at Pund-IT Inc. “However, I believe the company is looking at OpenAI as a longer-term change engine.”

Revenue in the Productivity and Business Processes group rose 13% in constant currency, to $17 billion, led by 20% growth in Dynamics products and cloud services revenue and 29% growth in Dynamics 365 sales.

The Intelligent Cloud business grew 24%, with Azure and other cloud services revenue growing 38% compared with the company’s own forecast of 37% growth and just 35% growth a quarter earlier.

As expected, revenue in the More Personal Computing category declined 16%, led by a 39% plunge in Windows OEM revenue. The drop was expected following an International Data Corp. report forecast last month that PC and tablet unit shipments would fall to 429 million units this year from 456.8 million last year, which was down nearly 12% from 2021. However, the $14.2 billion in reported revenue for the business was well below analysts’ expectations of $14.7 billion. “Performance in the U.S. was weaker than expected,” Hood said.

Microsoft’s fortunes are still tied too closely to PCs and cloud computing even as the company has invested heavily in enterprise applications, said Holger Mueller, vice president and principal analyst at Constellation Research Inc. “That will not change for the next three to five years,” he said. “The bets in games and hardware are not working – or have not taken off yet.”

Mueller noted that the total cost of revenue in the quarter grew more than 3% year-over-year despite revenue growth of less than 2%. “Microsoft has a cost problem; they spend too much to keep margins,” he said. “That does not bode well for cost control in the quarter.”

Pund-IT’s King agreed that the company is vulnerable to swings in consumer sentiment to a greater extent than purely enterprise-oriented firms. And although “inflation in the U.S. is easing, it is still a burdensome problem in many of Microsoft’s key global markets.”

Nevertheless, he expressed confidence in Chief Executive Satya Nadella’s leadership. “The changes are remarkable when you compare today’s Microsoft with where the company was a decade ago,” King said. “I expect those changes to continue and that the company will emerge stronger and better than ever.”

Photo: Microsoft