"Microsoft Gets Lift From Cloud Gains"
--The Wall Street Journal, July 19, 2016
Tech investors should be able to glean two important takeaways from the WSJ headline above. The first, that Microsoft's (NASDAQ:MSFT) stock popped in reaction to last week's earnings announcement, can be quickly verified elsewhere. See for yourself.
However, the second apparent takeaway, about the current state of affairs within Microsoft's cloud business, remains far less clear than that headline might lead you to think.
The tech giant uses an odd mix of reporting metrics to illustrate, or perhaps obfuscate, the progress of its cloud business -- its most important growth initiative against rivals like Amazon (NASDAQ:AMZN), IBM (NYSE:IBM) and Alphabet (NASDAQ:GOOG) (NASDAQ:GOOGL).
Microsoft's confounding cloud metrics
On the surface, Microsoft's cloud numbers give the appearance of impressive growth. In the conference call, Microsoft touted that its "commercial cloud" business achieved a $12 billion run rate, up nicely from $10 billion in its previous quarter.
Microsoft went on to report that sales from its "intelligent cloud" segment -- the actual cloud computing operating segment -- for the quarter totaled $6.7 billion, up 7%.
Muddling matters for investors trying to figure out how Microsoft's core Azure infrastructure-as-a-service (IaaS) business -- which competes with Amazon, IBM, and Alphabet -- is doing is that both the commercial cloud grouping and the intelligent cloud reporting segment contain other cloud-related pieces aside from Azure. Where exactly is the important Azure-only metric? Nowhere, unfortunately.
In its quarterly 10-Q filing with the SEC from April, Microsoft breaks out the specific products it includes in its commercial cloud figure in the following way, "Our commercial cloud ... primarily comprises Office 365 Commercial, Microsoft Azure, and Dynamics CRM Online." As such, Microsoft's commercial cloud pulls sales from two different official reporting divisions -- intelligent cloud and productivity and business processes -- each of which contains several unique products, making it guesswork at best to glean how much of that stated $12 billion in sales belongs to which product.
The same problem exists in the intelligent cloud reporting segment, making it frustratingly difficult to gauge the progress of this strategic imperative. When Microsoft announced its new financial reporting structure, it outlined intelligent cloud as including "results from public, private and hybrid server products and services such as Windows Server, SQL Server, System Center, Azure, and Enterprise Services."
What about Azure?
Given all of that, one could review all of Microsoft's financial releases and still be unable to make an accurate appraisal of how its actual cloud computing is performing.
For the record, Microsoft has received criticism over this in the past. Last year, former CEO, largest individual shareholder, and sweat-stain aficionado Steve Ballmer called out Microsoft over the opacity in its cloud metric reporting. Here's what we do know about Azure, though.
According to its Q4 earnings release materials, Azure revenue grew 102% compared to last year, with customer usage also more than doubling. What's more, Azure's premium services also grew at over 100% for the eighth straight quarter. However, the fact that Azure grew so ferociously, but Microsoft's overall intelligent cloud division saw sales rise a mere 7% suggests one of two things. Either Azure remains a relatively minor component of Microsoft's cloud sales or Azure's growth was offset by steep declines in another area of the intelligent cloud reporting segment, which seems the less likely of the two possibilities in my estimation.
According to estimates from Goldman Sachs last year, Amazon leads the global market for IaaS, holding a market share slightly over 50%. Microsoft claimed an estimated 10% of the market, while IBM and Alphabet rounded out the top four with 7% and 5% of the market, respectively. Goldman's estimates also estimated the IaaS market produced $21 billion in sales last year, which jibes with our working understanding of Amazon's stated revenue run rates for AWS.
Since these numbers seem roughly in line with other reports, we can estimate that Microsoft, IBM, and Alphabet saw 2015 IaaS revenues of $2.1 billion, $1.5 billion and $1.05 billion respectively. Viewing this from a quarterly perspective, it seems plausible that Microsoft's Azure sales now exceed $1 billion, as Microsoft said revenue more than doubled in the most recent quarter. However, that falls well below the quoted headline cloud figures Microsoft pitched in its earnings release. That's a crucial distinction anyone considering investing in the tech giant needs to understand.