Microsoft Earnings: Growth In Cloud Boosts Revenue Once Again

Microsoft (NASDAQ:MSFT) announced its earnings for Q2 FY17 on January 26. (Fiscal years end with June.) ^[1] The company posted 2% year-over-year growth (4% in constant currency)  in revenues to $26.06 billion (excluding LinkedIn Revenue). In our pre-earnings note, we noted that cloud services would boost revenues across the Productivity and Business Processes and the Intelligent Cloud segments. The Commercial Cloud annualized revenue run rate exceeded $14 billion, and the company is on course to achieve $20 billion annual run rate by the fiscal year 2018. As a result, the stock was trading at an all-time high on Thursday (after market hours). The highlights from the earnings announcement is as follows.

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 7% in constant currency), driven by Office 365 commercial revenue growth of 47% (up 49% in constant currency). Monthly active users of Office 365 commercial now number over 85 million, up more than 37% year over year, while the Office 365 consumer subscriber base grew to 24.9 million, resulting in 8% 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 7% (up 9% in constant currency) driven by Dynamics online revenue growth. Dynamics 365 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. Additionally, the management said that “the combination of LinkedIn Business Solutions and Dynamics 365” gives the company a comprehensive portfolio of business SaaS solutions that strengthen its position in the growing CRM market.

Server & Cloud Witness Another Quarter Of Strong Adoption

Microsoft’s Windows Server division contributes over 30% to our estimated stock price. During Q2FY17, the intelligent cloud segment (Azure, Server products, and enterprise services) delivered $6.86 billion in revenues, a year-over-year growth of 8% (10% in constant currency). While server products and cloud services revenue grew by 12% (14% in constant currency), driven by growth in Microsoft SQL Server, adoption of the cloud-based Azure platform resulted in 93% growth (95% in constant currency) in its revenues. As a result of these products, the company’s cloud revenue run rate exceeded $14 billion. However, Enterprise Services revenue decreased 4% (down 2% in constant currency) with declines in custom support agreements offset by growth in Premier Support Services and consulting. We’re encouraged by the continual growth that this division posted, and it is becoming an important driver for Microsoft’s value.

Despite Growth In OS Licensing Revenue Stabilizes And Xbox Live, Decline In Devices Sales Dents Topline Growth   

Windows Operating system division is the third largest division and makes up 5.8% of Microsoft’s estimated stock price. During the quarter, Microsoft’s More Personal Computing segment declined by 5% (down 4% in constant currency) to $11.8 billion, driven primarily by lower phone revenue.

Microsoft reported that its Windows OEM non- Pro licensing revenues grew by 5% and its OEM Pro revenue grew by 6%. Despite the slowdown in PC hardware sales, the company was able to buck this trend as license sales grew due to improvements in both the commercial PC market and the mix of premium devices. 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.

The company reported that Microsoft’s XBox Live continues to find favor among gamers. With nearly 55 million Xbox Live users, the company generated over $3.6 billion revenues during the quarter. While gaming revenue declined 3% (or 1% in constant currency) due to lower console hardware revenue, strong engagement on Xbox platform resulted in 18% growth (21% in constant currency) in revenues with digital transactions worth $ 1 billion in the quarter.

Microsoft’s devices continued to perform poorly as revenue decreased 35% (down 34% in constant currency) due to an 81% (81% in CC) decline in phone hardware revenue. Additionally, Surface revenue decreased 2% (flat in constant currency), driven by fatigue in its product line. However, the company did announce the launch of new hardware in November and is expected to update its Surface line of devices in 2017. We expect the sales to pick up as the Company launches new hardware.

We are in the process of updating our Microsoft model. At present, we have $58.69 price estimate for Microsoft, which is 8.6% below the current market price.

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1. Earnings Release FY17 Q2, January 26 2017 [↩]