Microsoft Earnings: Cloud Adoption Takes Center Stage As Revenue Improve Slightly

Microsoft (NASDAQ:MSFT) announced its earnings for Q1 FY17 on October 20th. (Fiscal years end with June.) ^[1] The company posted a 3% year-over-year growth (5% in constant currency)  in revenues to $20.453 billion. In our pre-earnings note, we noted that cloud services would boost revenues across productivity and business processes and intelligent cloud divisions. Commercial cloud annualized revenue run rate exceeded $13 billion, and the company is on course to achieve $20 billion annual run rate by fiscal year 2018. As a result, the stock was trading at all-time high on Thursday (after market hours).

However, the secular decline in PC shipments, together with the rising popularity of Chrome OS, impacted revenues for personal computing division.  Below, we review Microsoft’s Q1 FY 17 (Q3 CY2016) results by segment.

See our complete analysis of Microsoft here

Increasing Adoption Of Cloud Boosts Productivity And Business Processes Division

Microsoft has been able to leverage the popularity of its enterprise offerings to cross sell its cloud SaaS products. During the quarter, Microsoft reported that its Office commercial products and cloud services revenue grew 5% (up 8% in constant currency), driven by Office 365 commercial revenue growth of 51% (up 54% in constant currency). Monthly active users of Office 365 commercial are now over 85 million, up more than 40% year over year, while Office 365 consumer subscriber base grew to 24 million resulting in 8% (8% in constant currency) growth in Office consumer and cloud services revenue.

Microsoft’s Dynamic cloud services continue to report an increased adoption, as Microsoft’s clients continue to adopt the CRM and ERP services that deploy machine learning and intelligent cloud to glean insights from previously siloed data to transform how people work across finance, sales, marketing and customer service. During the quarter, Dynamics products and cloud services revenue grew 11% (up 13% in constant currency) driven by Dynamics online revenue growth. Dynamics online paid seats more than doubled year over year.

We expect Dynamic ERP and CRM revenue will continue to grow as it offers the benefit of cloud and the backing of Microsoft’s ecosystem of services.

Server & Cloud Witness Another Quarter Of Strong Adoption

Microsoft’s Windows Server division is one of the fastest growing divisions of Microsoft and contributes over 30% to Trefis’s estimated stock price. During Q1FY17, the intelligent cloud segment (Azure, Server products and enterprise services) delivered $6.28 billion in revenues, a year-over-year growth of 8% (10% in CC). While server products and cloud services revenue grew by 11% (13% in constant currency), driven by growth in Microsoft SQL Server, adoption of the cloud-based Azure platform resulted in 116% growth (121% in CC) in its revenues. As a result of these products, the company’s cloud revenue run rate exceeded $13 billion. We’re encouraged by the continual growth that this division posted, and it is becoming an important driver for Microsoft’s value.

OS Licensing Revenue Stabilizes As New Metrics For Gaming Indicates Growth For Xbox Live, Devices Revenues Continue To Flounder   

Windows Operating system division is the third largest division and makes up nearly 6% of Microsoft’s estimated stock price. While Microsoft reported that its Windows OEM non- Pro licensing revenues declined by 1% and its OEM Pro revenue grew by 1%. The declines are the result of slowdown in global PC industry. Recent data from Gartner indicates that PC shipments declined by 5.7% in Q3 2016. ^[2]  However, the company was able to buck this trend as license sales declined at a slower pace due to a the ecosystem of its services that is endorsed among enterprise clients. Furthermore, as both its existing and new OEM partners are bringing to market an expanded set of device offerings at lower price points for Windows 10 offering, we expect sales to pick up in the coming quarters.

This is the first time that the company has disclosed the topline numbers for its gaming division. The reported numbers indicates that Microsoft’s XBox live continues to find favour among gamers. With nearly 47 million Xbox live users and an installed base of 60 million Xbox 360 consoles, the company generated over $1.8 billion revenues during the quarter. While gaming revenue declined 5% (or 4% in constant currency) due to lower console hardware revenue, strong engagement on Xbox platform resulted in 21% growth in monthly active Xbox live users. As a result, software and services revenue from console, PC in other gaming devices grew 6% (or 8% in constant currency).

Microsoft’s devices continued to perform poorly as revenue decreased 27% (down 25% in constant currency) due to a 72% (71% in CC) decline in phone hardware revenue. However, Surface revenue increased 38% (39% in constant currency), driven by year-over-year growth for surface Pro. We expect that, as the company is nearly done with phasing out its phone hardware, the revenue for the devices segment will report growth in the coming quarters.

Online Service Division (OSD)

The online services division also reported some encouraging signs as online search advertising revenue grew 9% to over $1 billion. Furthermore, search advertising revenue improved due to increased revenue per search resulting from ongoing improvements in ad products and higher search volumes. We forecast Bing’s global market share to increase steadily throughout our forecast period but any surprises to the upside are not expected to increase the company’s value substantially.

We are in the process of updating our Microsoft model. At present, we have $56.05 price estimate for Microsoft, which is 8% below the current market price.

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1. Earnings Release FY17 Q1, October 20 2016 [↩]
2. Gartner Says Worldwide PC Shipments Declined 5.7 Percent in Third Quarter of 2016, October 11 2016 [↩]