Microsoft & Google Earnings Reviews
Exploring the results of these two titans.
1. Microsoft (MSFT) – Earnings Review
Microsoft beat revenue estimates by 1.8% and beat its guidance by 1.5%. Its 12.9% 3-year revenue compounded annual growth rate (CAGR) compares to 14.9% last quarter and 13.9% 2 quarters ago. It also beat its 26.5% Y/Y constant currency (CC) growth guide by 150 basis points (bps; 1 bps = 0.01%). Azure’s overall 30% Y/Y growth was roughly 200 bps better than expectations as well. That’s its fastest Azure growth rate in 4 quarters.
Please note that organic growth ex-Activision Blizzard M&A was about 13.8% Y/Y.
Microsoft beat EBIT estimates by 3.3% and beat its EBIT guide by 4.6%. It also beat $2.77 GAAP earnings per share (EPS) estimates by $0.16. Activision added 11 percentage points to Microsoft’s Y/Y operating expense (OpEx) growth. OpEx growth was 14% Y/Y and would’ve been 3% Y/Y ex-M&A. This means Activision is somewhat of a margin drag considering the smaller benefit to revenue. EBIT margin would have been 44.3% ex-Activision.
A few other notes to call out about margins this quarter:
A delay in payment to a vendor led lowered capital expenditures (CapEx) during the quarter. This helped cash flow margins.
Margin expansion was bolstered by an $800 million severance charge taken in fiscal Q2 2023. This made Y/Y comps easier.
c. Balance Sheet
Roughly $81 billion in cash & equivalents.
$72 billion in debt.
Dividends rose 10% Y/Y.
It repurchased another $4 billion in stock and saw very modest share count shrinkage Y/Y.
d. Next Quarter Guidance
Its $60.5 billion revenue guide missed estimates by 0.8%.
Its $25.95 billion EBIT guide beat estimates by 5.3%.
Guided to stable 28% Y/Y constant currency Azure growth. Last quarter, it told us to expect 26.5% Y/Y constant currency Azure growth for this quarter and the next two. This was a raise.
Other items in the guide include continued healthy commercial bookings growth and a material rise in Q/Q CapEx due to the aforementioned payment delay. LinkedIn growth should be roughly 9% Y/Y.
It also guided to full year EBIT margin expanding 100-200 bps Y/Y. This compares to estimates of roughly flat Y/Y EBIT margins. Strong.
e. Call & Release Highlights
Key Demand Metrics:
Commercial bookings and demand were better than expected thanks to long term Azure contract strength. Commercial bookings rose by 17% Y/Y (9% constant currency).
Current remaining performance obligations (cRPO) rose 17% Y/Y to $222 billion. Robust cRPO growth is a great sign for strong forward looking demand.
Cosmos Database (DB) enjoyed 42% Y/Y growth in data transactions thanks, in part, to the 50% efficiency gains it delivers.
Office Commercial Products & Cloud Services revenue rose 15% Y/Y while Office Consumer Products & Cloud Services saw 5% Y/Y growth. Microsoft 365 now has 78.4 million consumer subscriptions, which rose 15.8% Y/Y. Commercial 365 seats rose 9% Y/Y to cross 400 million.
Windows revenue rose 9% Y/Y; devices revenue fell 9% Y/Y; Xbox content and services revenue rose 61% Y/Y (6% Y/Y ex-Activision).
Key Margin Metrics:
Cloud gross margin was flat Y/Y. It was up 100 bps excluding the impact of a change in accounting estimate for useful life of assets in the Y/Y period. This made comps more difficult. Microsoft cloud gross margin was 72% vs. 73% Q/Q & 72% Y/Y. EBIT margin for intelligent cloud expanded by an impressive 580 bps Y/Y. That made some jaws drop… including mine.
Productive and Business Processes gross margin expanded a bit Y/Y while OpEx fell 5% Y/Y. Again, this was helped by easier comps related to the severance charge in the Y/Y period.
Personal Computing gross margin improved materially Y/Y while OpEx rose 38% Y/Y, but fell 10% Y/Y ex-Activision. EBIT margin improved 200 bps Y/Y for the segment.
Microsoft has taken arguably the most aggressive and direct approach to monetizing generative AI. It’s not just using it to make existing products better; it’s bundling all of the new utility into new subscriptions and software upsells via its “Copilot” offering. Copilot was first integrated into Microsoft GitHub, but is quickly making its way to the rest of the product suite.
Incredibly, Generative AI added a full 600 bps to Azure’s growth for the quarter vs. 300 bps Q/Q. This is not a pipe dream. This is not theoretical. GenAI is making a large financial impact right now for an already massive company.
Copilot is not a one-size-fits-all add-on… and far from it. Copilot Studio allows customers to tailor and customize industry-specific needs to make the “work companion” even more relevant to their own productivity.
Azure had another remarkably strong quarter. It’s outgrowing its second best competitor in Google Cloud despite having a far larger revenue base. I’m sure AWS’s growth rate will be well below 30% Y/Y as well. Azure AI customers rose by roughly 50% Y/Y; its advantage in cost of model training and inference stands out in today’s competitive environment. It offers access to a bevy of large language models (LLMs) including Meta’s, OpenAI’s, Cohere’s and its own. Satya walked through a long list of large clients like Walmart using Azure AI. In total, 50% of the Fortune 500 use this service today.
Azure is enjoying a “more frequent” pace of large deals flowing in. Imperatively, the “period of massive optimization of cloud workloads has ended” per CEO Satya Nadella. Less optimizing means more demand for new workloads. This is not only good news for Azure, but basically all companies reliant on cloud-based revenue growth.
GitHub & Developers:
GitHub is Microsoft’s end-to-end development and operations (DevOps) product with tools such as source code repositories. It competes directly with GitLab. GitHub revenue accelerated beyond 40% Y/Y thanks to vast Copilot adoption. Specifically, GitHub Copilot subscribers rose 30% Q/Q to reach 1.3 million.
Power Platform, Windows and the Future of Work:
Dynamics 365 “took more market share.” 365 users with Copilot reportedly complete basic tasks 29% faster than non-users.
Usage of cloud delivered Windows rose 50% Y/Y; Windows 11 commercial deployments doubled Y/Y.
LinkedIn has over 1 billion members vs. 985 million Q/Q; profile skills rose 80% Y/Y as engagement remains strong. Advertising demand was “about as expected.”
230,000 customers are now using its suite of AI tools on the Power Platform specifically.
The Activision Blizzard deal closed during the quarter and vastly propped up Y/Y personal compute growth metrics.
With Activision, it now has 200 million gaming monthly active users (MAUs) with the inorganic infusion helping gaming hours streamed rise by 44% Y/Y.
Importantly, on the call, CFO Amy Hood told us that personal computing demand is “stabilizing.”
I feel like I can copy the “take” section from each previous review and paste it here. The same is true every single quarter: Microsoft is a best-in-class performer, operator and now stakeholder in the world of Generative AI. This company performs every single quarter with little drama regardless of the macro backdrop or exogenous headwinds. Satya Nadella is a superstar and this quarter simply provides more evidence. Congrats to shareholders on what I view as a very positive print. Enough said.
If you find these free, detailed reviews valuable, you can subscribe below to have them sent right to your inbox. We cover dozens of popular companies, macroeconomics and sprinkle in plenty of opinion/insight. We save you hours upon hours of time in the struggle to keep up with investment research. We make stock picking doable for the busiest of schedules. Check it out.
2. Alphabet (GOOGL) – Earnings Review
Google beat revenue estimates by 1.2%. Its 14.9% 3-year revenue CAGR compares to 18.4% last quarter and 24.9% 2 quarters ago.
Cloud revenue was 1.7% better than expected as well. Google advertising revenue as a whole missed expectations by roughly 0.5%. This is what most on the street are pointing at to justify this evening’s price action. I think that’s a reach and trying to assign meaning to a few % move from a very hot stock.
Google met GAAP EBIT estimates and beat $1.60 GAAP EPS estimates by $0.04. Google paid a $10.5 billion tax payment on October 16th. Without this payment, free cash flow (FCF) would have been $18.4 billion for a FCF margin of 21.3%. $18.4 billion is about 20% above consensus expectations (smaller sample size of estimates vs. EBIT and EPS is why I use “about” here).
c. Balance Sheet
Share count is down 2.5% Y/Y.
$113.7B in cash & equivalents; $15B in debt.
Google doesn’t generally offer concrete forward guidance, and didn’t this quarter either. The team talked about maintaining healthy YouTube growth, cloud growth and cloud margin expansion. It also sees “notably larger” CapEx in 2024 vs. 2023 to support GenAI infrastructure. It told us last quarter that revenue growth in 2024 would be faster than OpEx growth. The lack of updates here makes me assume that’s still the plan.
e. Call & Release Highlights
GenerativeAI Overall and Search Specifically:
Like for Microsoft, this was a key theme on the call. Google has a series of foundational models under the “Gemini” umbrella that it’s using across its entire product suite. “Gemini Ultra” is its latest iteration, which is “coming soon.” It’s not yet monetizing it as meaningfully as Microsoft has, but it is enjoying “more AI contribution” in its results. To ensure customers can build whatever they want in a maintained, stable Google environment, it offers “Vertex AI.” Vertex AI is Google’s environment for GenAI app creation from 3rd party developers and its own. Usage of Vertex’s application programming interfaces (APIs) rose 600% Y/Y.
Search Generative Experience (SGE) and Bard are two search-based examples of where GenAI is being used. The products are somewhat similar, but Bard is more conversational while SGE mainly uses GenAI to enhance search result quality. Both are using Gemini; SGE has already cut query latency by a full 40% with it. Google’s team was asked a few times about GenAI search competition and how the landscape is shifting. It dismissed these questions consistently and talked up excitement for the future opportunity.
GenerativeAI and Advertising:
In advertising, Google is using Gemini to accelerate campaign content creation with things like “Auto Created Assets.” This allows ad buyers to surface more relevant results for potential customers with more granular segmentation to improve conversion. Somewhat relatedly, it’s also using Gemini in its Performance Max (PMax) campaign service. PMax is a campaign creation tool that aggregates Google and 3rd party impressions for advertisers to choose from. This has been shown to raise conversion for advertisers by 18% thanks to the larger roster of relevant impressions to select. For things like image discovery campaigns, PMax is raising conversion by another 6%.
During the holiday season, in which retail was the standout segment for Google ad demand, PMax delivered a 60% boost to return on ad spend (ROAS) for a “U.S. big-box retailer.” It raised conversion by 15% for a “global fashion brand” thanks to an omni-channel activation to extend the campaign into buy online, pickup in store.
Google is now working on a new conversational experience within Google Ads (think Bard for campaign creation). It’s in beta testing and is expected to enhance campaign performance and so demand for Google’s advertising tools.
Notably, from a macro point of view, consumers remain in thrifty and deal-hunting mode.
Google’s roster of subscriptions now represents a $15 billion business annually. It’s also growing quite nicely with Google One (more storage and tools) crossing 100 million subscribers; both YouTube TV Premium and YouTube Music continue to grow as well. It again spoke on how pleased it is with year one of NFL Sunday Ticket rights.
“Google One is doing incredibly well.” – CEO Sundar Pichai
First and foremost, the sequential acceleration in growth, the revenue beat vs. expectations and the resumption in sequential operating leverage were all notable highlights here. That cannot be overstated.
Google Cloud deepened McDonald’s and Verizon relationships during the quarter with AI product add-ons. AI model-building powerhouses like Anthropic are also using Google Cloud’s AI hyper-computer to train its own models. It’s supposedly enjoying key model training cost benefits from doing so.
Its YouTube create app is “putting production studios in the palm of a consumer’s hand” with GenAI. This app can now translate videos into several languages and automate content creation and delivery as well.
Google again told us that YouTube Shorts boasts 2 billion users and 70 billion daily views. These metrics are unchanged from last quarter. I would’ve loved to see continued growth in views.
Google debuted a “less disruptive” ad format in Shorts this quarter, which is part of its plan to continue closing the monetization gap for Shorts vs. traditional content.
It also debuted an interactive ad format. With it, consumers can engage with TV-based ads on their phones to more easily convert eyeballs into revenue.
As part of its ongoing cost cutting work, which includes layoffs, real estate footprint shrinkage and more, Google continues to make moves. This quarter, it combined Nest, Pixel and FitBit device teams into a consolidated “devices team.” What a concept. This should lead to lower headcount needs, streamlined work and better efficiency. It also wound down lower priority projects during the period.
CFO Ruth Porat is “pleased with the progress” Google is making in “re-engineering the cost base.” It will continue to very selectively hire only engineering and other technical talent. It will also continue to hunt for middle management layers to remove from the organizational structure — just like Meta did. The two companies continue to mimic each other’s CapEx, data center and cost cutting moves.
Still, CapEx will ramp for Google in the coming quarters to support infrastructure investments needed to be a core GenAI player for years to come. That means near term cash flow headwinds, but it is working on data center layouts and other ideas to improve technical efficiency.
More Interesting Nuggets:
Waymo passed 1 million fully automated trips.
Accenture is training 90,000 consultants on Google GenAI services. The two are teaming up to build the “GenAI center of excellence.”
I was candidly surprised by Google’s reaction to this report. It was likely just a matter of a very hot stock delivering a rock-solid, but not blow-out quarter. I truly don’t think there are any red flags here to point to, and don’t think bulls should be feeling anxious about this report at all. The FCF hit is purely based on a one-time payment and the cloud outperformance was encouraging.
Even as long term investors, it’s never fun to see a stock sell off after earnings. In my non-shareholder opinion, I think shareholders should exhale, zoom out, and think of the investment case as firmly intact. Feel free to disagree, as always. The main item, beyond cloud performance, that would change my opinion is deteriorating search market share via new entrants like Perplexity and ChatGPT. I haven’t seen any material evidence of that happening.