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February 24, 2024

Microsoft Beats on Strong Cloud and AI Growth, But Shares Dip on Margin Concerns

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Jan 31, 2024

Microsoft reported better-than-expected fiscal second quarter 2024 earnings results driven by strong growth in its cloud and artificial intelligence businesses. However, shares dipped slightly in after-hours trading due to investor concerns around compressed margins resulting from its heavy investments into AI.

Key Takeaways

  • Revenue rose 18% to $52.7 billion, topping analyst estimates
  • Azure cloud revenue growth accelerated to 31%
  • LinkedIn ad revenue jumped 22%
  • Gaming revenue soared 49% following the Activision Blizzard acquisition
  • Operating margins compressed from last year amid increased spending on AI
  • Microsoft expects to spend $20 billion on OpenAI through 2029

Strong Demand Across Most Segments Boosts Revenue

Redmond-based Microsoft posted Q2 sales of $52.7 billion, up 18% and exceeding Wall Street forecasts. Performance was broad-based, with every segment except Surface PCs delivering double-digit percentage growth.

The largest drivers continued to be Microsoft’s market-leading Azure public cloud and productivity suites like Office 365. However, gaming also posted explosive growth following Microsoft’s pending $69 billion takeover of games giant Activision Blizzard.

“AI is fundamentally changing every software category from cloud to edge to hybrid,” said CEO Satya Nadella on the earnings call. “We are focused on embedding AI across our platforms to help every organization transform.”

Breakdown by Segment

Segment Revenue (USD billions) Year-over-Year Change
Productivity & Business $17.0 19%
Intelligent Cloud $21.5 31%
Personal Computing $14.2 13%

Investments in AI Weigh on Margins

Microsoft has been pouring cash into artificial intelligence, including a multi-billion partnership with AI startup OpenAI. While these investments are driving top-line growth, they have put pressure on profitability.

Operating margins declined year-over-year to 39% from 42% last year. Gross margins also compressed to 65% from 70% previously. This suggests that Microsoft’s heavy AI spending has not yet started yielding efficiency gains to offset the higher costs.

CFO Amy Hood noted on the call that Microsoft expects margins to remain challenged over the next few quarters as it continues ramping up investments in AI. Hood said Microsoft plans to spend $10 billion on OpenAI over the next few years, up from the $5 billion it previously earmarked.

Cloud Growth Decelerates but Still Strong

Microsoft’s Azure cloud computing business has been its primary growth engine in recent years. While Azure revenue continued expanding at a strong clip, rising 31% this quarter, that was a deceleration from the 35% increase last quarter.

Some analysts were disappointed by the slowdown, given that the cloud market is still in the early innings of enterprise adoption. The moderation indicates competition is intensifying from rivals like Amazon Web Services.

However, Azure remains firmly in second place behind AWS with over $21 billion in quarterly revenue. Microsoft expects to continue gaining share as more workloads shift to the cloud.

Gaming Surge from Activision Deal

Microsoft gaming revenue skyrocketed 49% to $7.3 billion following its pending acquisition of Activision Blizzard. Activision will give Microsoft control of popular franchises like Call of Duty and World of Warcraft while allowing it to better compete against gaming leaders Tencent and Sony.

The deal is still undergoing regulatory review but Microsoft expects it to close by June 2023. Once finalized, the addition of Activision is forecasted to make gaming Microsoft’s second largest division after productivity software.

Outlook and Valuation

Microsoft issued upside guidance for fiscal Q3, projecting total revenues of $50.5 billion to $51.5 billion compared to consensus estimates of $49.9 billion. It expects robust enterprise demand across cloud, software, AI, and cybersecurity offerings.

While shares initially dipped around 3% after hours on the margin concerns, analysts broadly remained bullish on Microsoft’s long-term positioning.

“Microsoft continues to perform well across all metrics and we see the stock as attractively valued for the projected growth rates,” said Daniel Ives, analyst at Wedbush Securities.

Even with the after-hours decline, Microsoft stock is still up over 8% year-to-date, outperforming the S&P 500. At around 30x forward earnings, shares trade at a premium to the market but a discount to high-flying tech stocks.

Final Thoughts

Microsoft turned in a mixed quarter with several positives like accelerating Azure growth and minimal negatives like compressed margins. While profits are being challenged in the near-term by its bold bets in emerging categories like AI, Microsoft is cementing its competitive positioning for the next decade in the process.

For long-term investors, Microsoft remains an attractive core portfolio holding supported by durable growth drivers like cloud, software, AI, and gaming. Despite rich multiples, shares still have visible upside if execution remains solid.

AiBot

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AiBot scans breaking news and distills multiple news articles into a concise, easy-to-understand summary which reads just like a news story, saving users time while keeping them well-informed.

To err is human, but AI does it too. Whilst factual data is used in the production of these articles, the content is written entirely by AI. Double check any facts you intend to rely on with another source.

By AiBot

AiBot scans breaking news and distills multiple news articles into a concise, easy-to-understand summary which reads just like a news story, saving users time while keeping them well-informed.

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