Microsoft Cloud Push Gains Ground on Azure, Office 365

Jing Cao and Dina Bass (Bloomberg) -- Microsoft Corp.’s push into the cloud forged ahead last quarter, with demand for online versions of Office productivity software and the Azure web-services business bolstering sales and earnings.

Profit in the period that ended Sept. 30 exceeded analysts’ estimates and sales rose 12 percent to $24.5 billion amid buoyant demand for Azure cloud services, used to store and run customers’ applications in Microsoft’s data centers.

Chief Executive Officer Satya Nadella has turned Microsoft into a cloud-computing powerhouse, recently reshuffling the sales force and investing in new products and services. His efforts have helped win over customers like Bank of America Corp. for Azure, No. 2 behind Amazon.com Inc. in the biggest part of the cloud market, and internet-based Office 365 workplace tools. The changes also have the approval of shareholders, whose optimism has almost doubled the company’s stock price during Nadella’s three and a half years as CEO.

“The underlying momentum is pretty much in place, especially for the cloud effort,” said Sid Parakh, a fund manager at Becker Capital Management, which has $3.8 billion in assets under management. “Continued growth there and margin improvement there is really what I think is important from a stock standpoint.”

Related:Microsoft Switches to Multi-Zone Cloud Regions, Catching Up to AWS, Google Cloud

Net income in the recent period was 84 cents a share, Microsoft said Thursday in a statement. That compares with the 72-cent average estimate of analysts surveyed by Bloomberg.

Microsoft shares rose 4.3 percent to $82.15 in extended trading following the report, after closing at $78.76 in New York. The stock jumped 8.1 percent in the quarter, compared with a 4 percent gain in the Standard & Poor’s 500 Index.

Commercial cloud revenue was $20.4 billion on an annualized basis, meeting the company’s $20 billion target previously set for the fiscal year that started July 1. At the same time, as new data centers come online and become more efficient, Microsoft has been making progress in increasing the profitability of these services, with commercial cloud gross margin widening to 57 percent. Azure gross margins were a "key component" of the 8 percentage point improvement in commercial cloud services from the same period last year, Chief Financial Officer Amy Hood said.

"We’re seeing customers, as they continue to use Azure, start to consume the premium services," like AI and data analytics software that are much more profitable, Hood said in an interview. Azure margins were also helped by developments in the core hardware and software, she said.

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Azure sales rose 90 percent. Microsoft said earlier this month that Bank of America will use both Azure and Office 365 as it shifts more of its operations to the cloud. The Office product line, which consists of internet-based versions of Word, Excel and other workplace productivity software, posted sales growth of 42 percent. 

Continued fast growth, combined with spending discipline, in these two areas are what Wall Street is looking for, said Daniel Ives, head of technology research at GBH Insights.

“The one thing that had been maybe holding the stock back a bit was on the margin front,” he said. “Now you’re starting to see a $90-plus stock price becoming potentially achievable.”

Microsoft’s Azure service still lags behind market leader Amazon by a wide margin, but Microsoft is attracting more big customers, even as Amazon Web Services also notches strong growth. The rise in subscription sales for Azure and for corporate and consumer versions of Office 365 also provides more stable and recurring revenue.

Revenue has been patchier in personal-computer software and hardware. The overall market has continued to contract, and Microsoft’s Surface devices fluctuate in popularity based on competition and when new devices hit store shelves. Surface hardware sales jumped 12 percent largely driven by the new Surface Laptop. The segment declined earlier in 2017 owing to aging Surface Pro products that consumers shunned. This recent period was the first full quarter in which stores were stocked with an update to that product -- Microsoft’s best-selling Surface -- and a totally new category, a laptop computer with a clamshell design. Both devices went on sale June 15.

Total revenue in the company’s More Personal Computing division, which also includes the Windows operating system, was $9.4 billion, beating the $8.8 billion average estimate of four analysts polled by Bloomberg. Global PC shipments fell 3.6 percent in the period, according to Gartner Inc.

In the Intelligent Cloud unit, made up of Azure and server software deployed in customers’ own data centers, sales climbed 14 percent to $6.9 billion, compared with the $6.7 billion average analyst projection. Productivity revenue, mainly Office software, climbed 28 percent to $8.2 billion. Analysts had estimated $8 billion.

During the current quarter, the launch of the new Xbox One X console, combined with higher device sales during the holiday season, will pressure margins, Hood said on the call. The company expects revenue in More Personal Computing to reach as much as $12.1 billion. Hood also forecast as much as $8.95 billion in Productivity revenue, while Intelligent Cloud should book sales of $7.35 billion to $7.55 billion.