The markets have been on a wild ride as investors reassess the economic and monetary back drop. This has led to aggressive selling in the tech sector. Investors are turning in their tech chips in favor of cheaper cyclical names and, in some cases, cash and the sidelines.
This earnings season is a ‘white knuckle’ quarter for tech companies. Netflix (NFLX) highlighted the risk of missing your earnings when it saw shares tumble 20% in reaction to its poor performance.
This was the backdrop for Microsoft (MSFT) as it stepped into the earnings confessional. So how did they do?
First lets take review price action into earnings.
Microsoft shares nearly doubled during the pandemic, running from $179 in April 2020 to an all-time high of $349 in late November 2021. For a brief period last year, MSFT ranked as the most valuable company on the planet. A major beneficiary of the Work from Home movement, there are now more than 1.4 billion monthly active devices running Windows 10 or 11!
The stock pulled back approximately 16% from the all-time highs ahead of earnings. Interest rate worries led to some of the selling, but investors are questioning MSFT’s ability to sustain its incredible sales growth run.
MSFT’s Q3 revenue increased 20% to $51.7 billion, outpacing expectations by $1 billion. The beat was driven entirely from PC sales as the company’s More Personal Computing segment rose 15% in the quarter. This is part of the PC renaissance we have seen since the start of the pandemic.
The cloud and business software segments were in line with expectations and showed signs of deceleration as growth slowed to 46% year-over-year for Azure. This was in line with guidance but missed the street whisper numbers. Microsoft Cloud, which encompasses all the company’s cloud endeavors, rose 32% compared to 36% in Q2. This raised the red flag for investors. Shares tumbled to the $273 area in reaction, its lowest level since early July.
A deeper dive into the numbers highlights the strong demand for the company’s products.
Commercial bookings grew 32%, significantly ahead of expectations and well above the 14% growth in the prior quarter. The increase in bookings was driven by longer-term Azure contracts. Commercial remaining performance obligations increased 31% to a whopping $147 billion. Roughly 45% will be recognized in revenue the next 12 months, +26% year-over-year. These metrics underscore the strategic, long-term commitment that customers are making to MSFT from edge to cloud.
The company was able to redeem itself on the conference call as it forecast an acceleration in the cloud segment. This is a key area for MSFT as it is now the second largest competitor in the cloud business with 20% of the global computing market (Amazon is tops at 40%). Consumption trends in MSFT’s core cloud business are what matters the most to investors and they are rising, not slowing.
Azure now represents approximately 21% of MSFT’s reported total revenue and it is growing at close to 50% and generating higher margins.
The company’s Q4 projections for its Productivity and Business Process, Intelligent Cloud, and More Personal Computing were all in line or better with analyst expectations. MSFT stated that it was seeing strong demand across all its segments including security, cloud, and gaming. Making this even more impressive is MSFT’s penchant for providing conservative outlooks.
Shares were able to erase gains as investors started to digest the revenue runway and impressive outlook.
MSFT discussed the Activision (ATVI) deal on its call. It highlights the company’s push into the gaming sector, one more potential revenue stream for the goliath. We do have concerns about the deal as the Biden Administration appointed Lisa Kahn to head the powerful Federal Trade Commission. Ms. Kahn made a name for herself as a Yale professor when she penned a paper called The Amazon Antitrust Paradox. Ms. Kahn argued for the breakup of big tech in her paper.
The FTC sued Lockheed Martin (LMT) over it’s attempt to acquire Aerojet Rocketdyne (AJRD). Investors are questioning the deal as evident by ATVI shares trading at $78, well below the $95 offer.
Shares of MSFT are now battling with the $300 psyche level. The 200-day moving average also sits in this area at $293. The stock remains relatively expensive, trading at a forward earnings of 28x and a price to sales of 12.8x. These are not as egregious as some of the software company numbers, we saw in 2021 but it is a different environment. Still, it can be easily argued that MSFT deserves to trade at a premium to the market given its size and growth.
The backdrop will make it difficult for big tech names to rally aggressively. MSFT is setting up for a consolidation period in this $280-340 area. Long-term investors would do well to start building a position in this name and take advantage of the cloud revenue growth.