Three Key Questions About Microsoft (NASDAQ: MSFT) Earnings in July 2023

Microsoft (NASDAQ: MSFT) reported earnings for fiscal Q4 2023 after the market close on Tuesday, July 25, 2023. What happened during the release and earnings call, and what are the new questions to focus on?

1. What happened in Q4? (Hint: It’s all about the Cloud.)

Both Productivity & Business Processes and Intelligent Cloud (including Azure) came in slightly ahead of Visible Alpha consensus estimates for sales and operating profit.

In Q4, the Productivity and Business Processes segment delivered $18.3 billion in revenue and $9 billion in operating profit, resulting in a 49% operating profit margin, driven by strength in Office. For the full year, the segment delivered $69 billion in revenue and $34 billion in operating profit. Microsoft guided to $18-18.3 billion in Q1, in line with analysts’ estimates of $18.2 billion. In FY2024, Productivity & Business Processes is expected to grow to $77 billion, up 11.6% according to Visible Alpha consensus, with margins expected to be flat.

Prior to the Q4 earnings release, analysts expected the Intelligent Cloud business (including Azure) to continue to generate $88 billion in revenue for FY2023 and $102 billion for FY2024, and for operating margins to remain around 43% in FY2023 and FY2024. In Q4, Intelligent Cloud delivered revenue of $24 billion and operating profit of $10.5 billion, resulting in $88 billion in revenue and $38 billion in operating profit for FY2023, slightly ahead of expectations. According to management, Azure got a small boost from AI. Intelligent Cloud is expected to generate $23.5 billion (in line with guidance of $23.3-23.6 billion) in Q1 and to drive growth in FY2024. Microsoft noted that growth will be weighted to H2. The company will also increase CapEx to build out AI, but expects margins to remain flat.

CFO Amy Hood noted that Azure and other cloud services’ margins were lower, but that overall operating income grew 20% in Q4. In FY2024, Intelligent Cloud is expected to grow to $102 billion, up 16% year over year, and to $120 billion by the end of FY2025, according to Visible Alpha consensus. Some analysts are suggesting that the company can deliver better-than-expected growth in this business, with top-end estimates coming in closer to $105 billion in 2023 and $130 billion in 2025.

New Question: Will Azure’s growth and margin rebound in 2024?

2. CapEx is exploding: Where is Microsoft investing?

Microsoft’s CapEx levels by FY2025 are expected to be 10X from FY2013, 5X from FY2017, and 3X from FY2019. CapEx for Q4 came in ahead of expectations and was up 35% quarter over quarter to $8.9 billion, and 29% year over year to $28 billion for FY2023. The company guided to further increased sequential CapEx spending for cloud infrastructure in FY2024. Analysts are expecting CapEx to jump to $40 billion, up $12 billion and an expected increase of 45% year over year.

According to CEO Satya Nadella, the easiest path for companies to adopt generative AI is via Copilot and the Cloud. Microsoft wants to help customers build generative AI capabilities and expects this benefit to be weighted toward H2 2024. According to CFO Amy Hood, AI-related gross margins should scale faster and the pace of adoption should be quicker than in previous cycles.

According to Nadella, Microsoft is reshaping search with multi-modal capabilities and Bing is continuing to take share. According to analysts, MSFT’s Bing / display advertising business generated $3.1 billion in Q4 and $12.3 billion for FY2023, in line with expectations. For FY2024, analysts expect Bing to grow revenues to $13.2 billion.

New Questions: How quickly will CapEx investments to support AI start to add to growth at MSFT, and will these investments help drive more substantial ad revenue growth at Bing?

3. What’s happening with the Activision Blizzard Deal?

According to CEO Satya Nadella, the company is committed to getting the deal done. Analysts expected MSFT’s Gaming business to generate $16 billion in revenues for FY2024. According to Visible Alpha consensus, Activision Blizzard (NASDAQ: ATVI) is expected to generate $9.4 billion in revenues in 2023 and $3 billion in operating income. Microsoft did not provide guidance or additional details around this pending deal.

New Question: Will the deal pass regulators and get done?