Microsoft & Google Earnings Reviews

Digesting the results of these two titans.

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1. Microsoft (MSFT) — Earnings Review

a. Demand

• Microsoft beat revenue estimates by 3.5% & beat its guidance by 4.1%.

• Azure beat 27.2% constant currency growth estimates by nearly 200 basis points (bps) and beat Microsoft’s guidance by nearly 350 bps. AI services added 300 bps to Azure growth which was better than expected.

• Its 14.9% 3-year revenue growth compounded annual growth rate (CAGR) compares to 13.9% Q/Q & 14.8% 2 quarters ago.

b. Margins

Microsoft beat EBIT estimates by 0.8% and beat its EBIT guidance by 1.0%. The company also beat $2.65 GAAP earnings per share (EPS) estimates by a robust $0.34. EPS rose by 27% Y/Y.

c. Balance Sheet

• $143 billion in cash & equivalents.

• $66 billion in debt ($26 billion is current or due within 12 months).

• Dividends up 9.3% Y/Y; $4.8 billion in buybacks vs. $5.6 billion Y/Y.

d. Guidance

For next quarter, Microsoft beat revenue estimates by 3.9% and beat EBIT estimates by 6.8%. This includes a full quarter contribution from its Activision Blizzard M&A. It also told us that Azure will grow by around 26%-27% constant currency Y/Y for the next three quarters. Strong.

By segment, Productivity and Businesses Processes revenue will be around $18.95 billion, Intelligent Cloud will be around $25.25 billion and Personal Computing will be around $16.7 billion.

Finally, CFO Amy Hood reiterated that EBIT margin will be flat Y/Y in fiscal year 2024 despite Activision integration costs.

e. Call & Release Highlights

Microsoft Copilot:

Microsoft has been the most aggressive mega cap in terms of monetizing generative AI directly and expeditiously. It’s doing so through a product called Microsoft Copilot, which has already been infused into several of its products. A key theme of this call was adding Copilot to more Microsoft use cases.

Today, Copilot bolsters GitHub (source code writing) developer productivity by 55%. This tool just crossed 37,000 customers following 40% Q/Q growth. Copilot was added to its Power Platform (for app creation and data analytics) with 126,000 customers already using it. Microsoft’s Power Apps are ranked first in low/no-code developing market share with 20 million monthly active users (MAUs) — up 40% Y/Y. It’s easy to see how this success will be replicated within product areas like 365 where Copilot will become generally available next week for excel, powerpoint etc.

Generative AI Approach:

I’ve well documented how Microsoft’s monetization journey within GenAI stands in stark contrast to others like Meta. But there’s another interesting difference between the two partners. All Microsoft models pull from a singular foundational model. This is somewhat similar to Amazon and its Bedrock model. Microsoft takes a full stack approach. Within it, one model trains all others and just one more provides all inference help. It thinks this will allow it to scale with greater operating leverage. That is important considering how expensive GenAI models are to build and maintain.

Meta thinks models should be local and specific to more niche use cases. It’s building out dozens of independent models pulling from several foundational models rather than taking this centralized approach. It will be interesting to see how each plan works over time.

Azure:

Microsoft Azure continued to take more market share with that trend fully expected to continue. Cloud optimization trends didn’t improve or worsen sequentially, but demand for AI services powered the outperformance here. Azure is thriving. It’s bigger than competition like Google Cloud, yet growing faster and printing more profits. We’ll see how AWS’s performance compares when Amazon reports later in the week.

Azure’s OpenAI service, which offers access to OpenAI’s roster of models, reached 18,000 enterprise customers. Azure Arc is Microsoft’s cloud platform that offers customers access to its service in on-premise, hybrid and multi-cloud environments. Customers of this service rose 140% Y/Y to reach 21,000.

• Azure remains the partner of choice for giants like SAP and their customer workloads.

• Nearly 3/4 of the Fortune 1000 uses 3+ data cloud services from Azure today.

• Microsoft Fabric (which consolidates all cloud services including governance and security) eclipsed 50% of the Fortune 500 as customers.

Teams & 365:

Microsoft Teams crossed 320 million MAUs this quarter vs. 300 million 6 months ago. It just debuted a new version which halves latency and memory storage needs. Finally, Teams Rooms enjoyed its 9th straight quarter of triple digit Y/Y growth.

Microsoft 365’s most advanced, overarching license is called E5. It includes Teams, security, business intelligence and all 365 tools. Healthy renewals for E5 were cited by leadership as a contributing factor for the strong quarter.

Margins:

Cloud gross margin was about 100 bps (basis point; 1 basis point = 0.01%) better than expected thanks to Azure growth. It came in at 72% vs. 73% Q/Q and 70% Y/Y. Without a change in the estimate of useful life for certain assets, gross margin would have expanded by 200 bps Y/Y. Without this same change, EBIT margin would have been about 130 bps better for the quarter. This is why I want all companies to report GAAP & non-GAAP metrics… not just GAAP.

Segment Notes:

Productivity and Business Processes enjoyed 17.8% Y/Y consumer subscriber growth. The segment also saw 10% Y/Y Office 365 Commercial seat growth. Billings performed about as well as expected here.

Personal Computing fared much better than feared. Xbox content and services growth was the fastest it has been in over a year as comps get easier.

This quarter marked a 6 year high for Intelligent Cloud EBIT margin. Azure growth, maturity and scale are helping mightily.

Final Notes:

• Commercial bookings growth rose 7% Y/Y vs. -3% Y/Y growth last quarter and 32% Y/Y growth last year.

  • Commercial remaining performance obligations are $189 billion vs. $147 billion Y/Y for 28.6% growth. This is a strong indicator for future results.

• Windows 11 debuted its biggest update so far with 150 new AI infused tools and an integrated Copilot offering.

• Its security information and event management (SIEM) product crossed 25,000 customers and $1 billion in annual revenue. Microsoft thinks it’s taking share across all security segments.

• LinkedIn has 985 million members vs. 950 million Q/Q. Membership growth has accelerated every quarter for 2 straight years.

• Bing’s GenAI search tools (as announced by Meta) will be a big part of Meta AI’s own virtual assistant capabilities.

• The Activision Blizzard deal closure gives Microsoft 13 gaming franchises over $1 billion in annual revenue.

f. Take

This was a fantastic quarter from a fantastic team and a fantastic company. Fantastic. I’m not a shareholder, just an admirer. It’s hard to overstate how impressive the Azure results and guidance truly are. The call functioned as yet another victory lap to dig into all the large customer wins and product momentum it’s enjoying. The company’s future growth is priced for perfection, but that won’t matter if it keeps putting up perfect quarters. It continues to clear a sky-high success bar. Well done Satya… again.

2. Alphabet (GOOGL) — Earnings Review

a. Demand

Google beat sell side revenue estimates by 1.2%. The cloud segment, conversely, missed estimates by 1.5%. Its 18.4% 3-yr revenue CAGR compares to 24.9% Q/Q & 19.2% 2 quarters ago.

b. Margins

Alphabet met GAAP EBIT estimates and beat $1.45 GAAP EPS estimates by $0.10. It handsomely beat free cash flow (FCF) estimates by 42%. EPS rose by 46% Y/Y.

Y/Y operating leverage would have been even more meaningful if Google were not investing so meaningfully in expanding AI compute infrastructure to support future needs. The extension of the useful life of its some servers and data centers continues to lower depreciation expense and help profits. This has added $2.9 billion in EBIT and $0.18 in EPS so far this year. Meta is doing the same thing.

Google enjoyed a 7% effective tax rate via deferring cash tax payments to Q4. This helped profitability. Google made a $10.5B tax payment after this quarter ended which will hit margins in Q4. Something to note.

c. Balance Sheet

• $120B in cash & equivalents.

• $13.8B in long term debt.

• $45.3B in year to date (YTD) buybacks vs. $43.9B Y/Y. Share count fell by 3.1% Y/Y. Impressive.

d. Vague Guidance

When leadership was asked about costs growing more slowly than revenue in 2024, they loosely confirmed that, that would be the case. They also told us to expect CapEx to ramp for the next few quarters. Supporting AI infrastructure is expensive.

e. Call & Release Highlights

Where Generative AI Helps:

GenAI was shockingly a focal point of this call — I say oozing with sarcasm. The new technology is touching many, many parts of the company and it’s important to understand these dynamics.

First, Google’s conversational search use cases continue to sharpen and expand. This is juicing engagement and should lead to more advertising revenue over time.

Secondly, Google is finding more and more ways to automate and augment campaign creation for ad buyers. More effective mining and leveraging of data means raising conversation and revenue growth without boosting customer acquisition cost. That makes Google and its ad impressions even more appealing to buyers. It continues to test new formats and segmentation tools with the work from its Google Deep Mind research team.

Thirdly, generative AI is boosting productivity for all Google stakeholders. Bard (its GenAI search complement to Google Search) personally saves me hours per week via more directly fetching query results; I am far from alone. These newer tools are now being integrated into the rest of Google’s products to uplift the utility of its entire suite. For example, thousands of customers now utilize its GenAI tools within their Google Cloud environment. One of these tools is Assistant with Bard which is a digital, conversational assistant being broadly rolled out.

Interestingly, Pichai told analysts during the Q&A that subscription up-sells for its GenAI products are ON THE TABLE. This hints at it eventually taking a more direct approach to monetization like Microsoft has. This was a pleasant surprise to me.

Newer AI Tools:

Vertex AI is Google’s product environment for developers to build AI-infused apps. With it, developers can plug into the resources needed to craft custom generative AI use cases for industry-specific needs. It offers access to a bevy of open source models and saw active projects rise 700% Q/Q off of a small base. This will very closely plug into Gemini. Gemini is Google’s main large language multimodal model.

Google will soon integrate a conversational ad creation experience into Performance Max (PMax). PMax is a campaign targeting and perfecting automation tool. It is also a key piece of marketers extending granular targeting to physical stores with the same precision as online. PMax delivers 18% higher conversion rates for marketers vs. alternative options at a similar cost per impression.

Spotlight Moments is an AI tool to locate trending and relevant content for brands. With this tool, advertisers get 54% more reach at 42% lower cost for video campaigns. For skippable ads across streams, AI campaign tools are bolstering views by 40% vs. only in-stream placements. If ads are actually relevant, some don’t even mind watching them.

• It just debuted the virtual trying on of clothing which is raising conversion and should trim return rates for merchant partners.

Macro:

For this holiday season, deal discovery queries are up several factors Y/Y while free shipping interest has skyrocketed. Consumers are looking to get more thrifty with their discretionary spending.

The ad demand environment is stable and may even be improving. This is wonderful news for the rest of the advertising space. Ad spend is inherently cyclical and this serves as evidence that the worst part of our current cycle may be over.

Cost Base Work:

Google’s work to trim the bloat from its cost base is ongoing. It continues to slow hiring pace, trim its real estate footprint and shift talent to its highest priority areas: AI, search and cloud.

YouTube:

The NFL Sunday Ticket partnership is off to a great start. It’s giving leadership confidence in this contract yielding a strong return on investment over the course of its life. That stands in stark contrast to Netflix intentionally avoiding live sports because it doesn’t think it can generate compelling returns. Google’s ability to do so is emboldening it to explore more live sports contracts. Maybe it’ll even purchase of Disney’s ESPN.

YouTube Shorts now enjoys 70 billion views daily. It was over 2 billion MAUs as of last quarter, but that metric was not updated. The always signed-in nature of this content is fostering strong ad rates and delivering lofty returns for buyers. The “monetization gap is closing” which is great news for both Google and likely Meta Reels too.

• Google just debuted Dream Screen to help users on YouTube automate pieces of their content creation.

• 150 million people watch YouTube monthly on connected TV screens.

Google Cloud:

Leadership was asked about the material slowing within the Google Cloud segment. It cited its decision to help customers with workload optimization while they cut costs. Microsoft and Amazon did the same thing. These optimization headwinds have stabilized, and CEO Sundar Pichai is “optimistic about what’s ahead.” I still would’ve liked to see a better result for the segment this quarter. Microsoft Azure’s 29% Y/Y growth and strong guide made Google’s performance look a tad underwhelming here. Azure is slowing more gradually on a much larger base and with much better margins. To be fair, Azure is a world-class business… but Google Cloud wants to be too.

Google continues to outgrow the industry as a whole and does serve a lot of technology startups. It serves the majority of funded generative AI startups for context (with a respectable roster of Fortune 500 brands). These startups will naturally endure and recover from economic challenges less gracefully than Fortune 500 brands (where Azure more sharply skews).

This was Google’s 3rd straight quarter of positive cloud EBIT. Still, the sequential margin expansion trend we’ve come to expect halted this quarter. This is not a concern if it does not persist. We’ll see if it does.

Hardware, Other Bets & final note:

• Its new Pixel Smartphones are the fastest growing across all core markets.

• Waymo continues to work through the 100,000 people in San Francisco on its driverless car waiting list. It will enter Dallas, Texas next.

• Google will move forward with 3rd party cookies deprecation next year. This will only apply to 1% of users so that it and developers can test efficacy of the newer product called Privacy Sandbox.

Restructuring:

• $2.1 billion in YTD severance charges.

• $649 million in YTD real estate footprint cutting charges & another $207 million charge this quarter for accelerated depreciation connected to this.

f. My Take

This quarter was fine. It continues to find material leverage while investing ahead of future opportunities. Google Search is among the best businesses in the world. Its leading market share means leading data share to more effectively season GenAI models vs. Microsoft for example. That edge should persist.

The ad market is showing signs of life and YouTube Shorts is thriving. The new AI tools create significant potential up-sell opportunity down the road. The weak spot of the print was within the cloud segment. The small miss on revenue and pause in Q/Q leverage doesn’t compare favorably to Azure. Still, the segment continues to find rapid Y/Y operating leverage and 22% Y/Y growth is nothing to sneeze at. Perfect? No. But still rock solid.