Microsoft (MSFT) Rallies on Earnings Quality, Generative AI Opportunity

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Shares of Microsoft (NASDAQ: MSFT) are trading higher Wednesday after the tech behemoth reported better-than-expected fiscal Q3 2023 results and issued an upbeat forecast.

For its fiscal third quarter, Microsoft reported earnings per share (EPS) of $2.45, topping the consensus projection of $2.23 per share, according to Refinitiv. Net income grew 9% year-over-year to $18.3 billion, or $2.45 per share, from $16.73 billion, or $2.22 per share, in the same quarter last year.

Revenue rose 7% YoY to $52.86 billion from $49.36 billion a year ago and above the analysts’ expectations of $51.02 billion.

Cloud Performance Better Than Feared

Microsoft’s Intelligent Cloud segment, which includes products such as the Azure public Cloud and Enterprise services, reported $22.08 billion in revenue, up 16% YoY and beating the consensus estimates of $21.94 billion. The company’s revenue from Azure and other cloud solutions rose 27% from the year-ago period and 31% quarter-over-quarter.

“The bottom line is that despite all the concerns that the sky is falling in big tech, the truth is companies still see value in cloud computing and there’s still a huge percentage of workloads that can be moved to the cloud,” said Bob O’Donnell, an analyst at TECHnalysis Research.

The company’s business segment, which involves Office products and LinkedIn, generated $17.52 billion in revenue, up around 11% YoY and topping the analysts’ estimates of $17.05 billion. Microsoft said strong revenue per user fueled the 14% revenue growth from its commercial Office 365 productivity software subscriptions.

Microsoft said its business communication platform Teams had more than 300 million monthly active users in the quarter, 20 million more than in the previous quarter, said CEO Satya Nadella.

The More Personal Computing segment, which entails Windows, Bing, Surface, and Xbox, posted $13.26 billion in revenue, down 9% from the year-ago quarter, though still above the analyst consensus of $12.25 billion.

According to Nadella, Bing now has more than 100 million daily active users, while revenue stemming from gaming subscriptions reached $1 billion.

The company’s sales of its Windows licenses to electronic device manufacturers fell 28% from last year, with elevated channel inventory levels weighing on the results.

The tech giant was expecting a poor performance in its Windows business, which heavily relies on PC sales that have significantly stagnated in the recent period. However, demand for PCs was slightly better than what the company had anticipated, said Microsoft’s CFO Amy Hood.

Moving forward, Hood said Microsoft expects revenue in the range of $54.85 billion to $55.85 billion for the fiscal Q4 2023. The middle point of that range of $55.35 billion, implies 6.7% growth and was above the consensus estimates of $54.84 billion, as per Refinitiv.

Analysts Focused on AI Opportunity

While the biggest portion of Microsoft’s revenue still comes from software sales and cloud services, the third-biggest company in the world by market cap has recently attracted further investor interest with its $10 billion dollar investment in OpenAI – an AI research laboratory behind the groundbreaking chatbot ChatGPT.

The integration of AI has become a major consideration for stock traders – both retail and institutional alike.

Moreover, the company has implemented the underlying ChatGPT technology into Bing, suddenly making the long-forgotten search engine the biggest threat to Alphabet’s Google.

During the earnings call, Nadella told investors that the company had over 2,500 Azure-OpenAI service users, adding that AI has been implemented into a broad range of its products. Hood said Microsoft feels optimistic about its AI push.

“As with any significant platform shift, it starts with innovation, and we’re excited about the early feedback and demand signals from the AI capabilities we’ve announced to date,” she said.

The company plans to keep investing in its “cloud infrastructure, particularly AI-related spend, as we scale to the growing demand driven by customer transformation. And we expect the resulting revenue to grow over time.”

Since Microsoft integrated AI features into Bing, page visits on the search engine between Feb.7 and March 20 increased by 15.8%, while Google saw a 1% decline during the same period.

The data highlights the lead Microsoft has taken in its intense generative AI battle with Google, which recently launched its own AI chatbot, Bard, in the US and the UK. But the recent Bing success also reveals a unique opportunity for Microsoft to expand its share in the $120 billion search market, which has been dominated by Google for decades.

Analysts expect Bing to continue gaining market share in the coming months, particularly if Google postpones the integration of generative AI features into its search engine. At the moment, Microsoft appears to be notably ahead in that race as Bing AI has been available to the majority of users since February, while Google publicly launched Bard last month.

“Bing has less than a tenth of Google’s market share, so even if it converts 1% or 2% of users it will be materially beneficial to Bing and Microsoft,” said Gil Luria, an analyst at D.A. Davidson & Co.

Since AI integration, app downloads for Bing have surged eight times on a global level, while downloads for Google’s search app declined by 2% during the same period, according to Data.ai.

The importance of generative AI for Microsoft is also seen in the number of “AI” mentions on the company’s earnings call. The AI opportunity has also prompted at least two sell-side analysts to raise their recommendations on Microsoft stock.

“While short-term stock movements are notoriously difficult to predict, our call has been to own Microsoft shares for category leadership in generative AI, which has the potential to increase the value proposition pervasively across the Microsoft stack. Aligning with our view, AI was mentioned 50 times during the earnings call and is clearly driving a reassessment of Microsoft’s value prop and differentiation,” JPM analysts wrote in a client note today.

UK Moves to Block Activision Deal

Meanwhile, Microsoft’s efforts to complete the biggest-ever gaming deal suffered a major blow after the planned acquisition of Activision Blizzard was blocked by the UK’s top competition regulator on Wednesday.

The move represents a major setback for Microsoft, which spent months trying to convince global regulators that the deal would be beneficial for competition. The tech company said it intends to appeal the decision.

Activision’s shares fell nearly 10% in premarket trading on the reports.

The U.K. Competition and Markets Authority (CMA) said it obstructed the deal due to competition concerns in the burgeoning cloud gaming market. Microsoft’s acquisition of Activision would make the latter’s games exclusive to the tech giant’s cloud gaming platform, affecting the distribution to other key players in the industry, the CMA added.

In the US, the Federal Trade Commission (FTC) has also put forth measures to block the acquisition, though Microsoft has said they will fight to push the deal forward.

Summary

Microsoft shares are trading higher Wednesday after the company reported stronger-than-expected FQ3 results. Moreover, investors were impressed to see the increasing focus on the generative AI opportunity with 2 analysts upgrading Microsoft shares following the earnings report.

Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.