Microsoft (MSFT -0.01%) has been one of the best market performers over the past few years, including 2019. For the year, Microsoft's stock is up almost 30%, on the heels of a very strong earnings report and guidance. For those not invested in Microsoft yet, you might think that you've missed out. Yet while the stock has had a strong run and currently trades at all-time highs, when one looks further out -- say, five years -- it's highly likely that Microsoft's stock will continue to be a strong performer.
Microsoft has long been associated with its Windows operating system and Office software tools. But while those products -- especially Office 365 -- will still be a significant part of Microsoft's business, the big reason Microsoft is poised to outperform in the future is newer, higher-growth businesses, especially Azure Cloud, Microsoft's infrastructure-as-service business.
Azure's strength is not only positive in and of itself, but Azure actually helps Microsoft grow sales of its other products as well. Here's how.
Intelligent cloud to surpass other segments
Microsoft doesn't specifically break out Azure's revenue and profit, though it does disclose Azure's growth rate, which came in at a whopping 73% last quarter -- the highest of any of Microsoft's products.
Azure is part of Microsoft's intelligent cloud segment, which also includes on-premise servers and software and enterprise consulting services. The intelligent cloud business is currently Microsoft's smallest segment; however, intelligent cloud grew 22% last quarter, faster than any of the others. Based on Microsoft's guidance, intelligent cloud could very well leapfrog to being Microsoft's largest segment as soon as next quarter:
FY Q3 2019 Revenue
FY Q3 2019 Growth Rate
FY Q4 2019 Revenue Guidance
Productivity and business processes
$10.55 billion to $10.75 billion
$10.85 billion to $11.05 billion
More personal computing
$10.8 billion to $11.1 billion
Microsoft is currently the largest company on earth by market cap, but as the higher-growth cloud segment takes over as Microsoft's largest one, it should sustain the company's mid-teens growth rate for years to come, despite its already-massive size.
A complete offering opens up markets
CEO Satya Nadella explained on Microsoft's recent conference call that Azure not only succeeds as an infrastructure service but also opens up entire new markets and enables it to sell other products:
...if you look at our cloud stack, we have application in infrastructure, data and AI, productivity and collaboration as well as business applications. That's pretty unique again. So that's I think what is showing up at scale as competitive differentiation and that's what you see in our numbers, but most importantly, I think you see it in the customer momentum and what I believe is what is customer success. Digital technology today is not about tech companies doing innovation. It is about the rest of the world doing innovation with technology and Microsoft is uniquely in position to enable that.
Nadella is saying that Microsoft's ability to offer a one-stop shop for a company's entire digital transformation needs -- infrastructure, platform, and software-as-a-service -- in addition to on-premise data center servers is a big competitive advantage. That has allowed Microsoft to better serve industries in which it historically had low penetration, such as retail, healthcare, manufacturing, and financial services.
Azure also spurs innovation
In addition, the cloud is paving the way for Microsoft to innovate entirely new products in future growth industries such as the Internet of Things and edge computing. One year ago, Microsoft said it would invest $5 billion over four years in its IoT business, and it recently acquired IoT leader Express Logic.
Microsoft is also tailoring existing platforms and software traditionally delivered on-premise for the Azure cloud, such as its Cosmos Database and cloud-delivered versions of Office and Dynamics, as well as newer services such as LinkedIn, GitHub, cybersecurity, and others.
How big will Azure be in 2024?
On the conference call, analyst Mark Murphy asked management if Azure could surpass Office 365 Commercial as Microsoft's biggest product in a few years. CFO Amy Hood didn't reject that assertion but also wanted to point out that Microsoft's other software businesses have a bright future as well:
[i]t certainly could be, but I don't want that to really diminish the fact that there is a lot of room for us in our per seat businesses, particularly in business applications across LinkedIn, the Power Platform work we're doing. Satya mentioned security, identity, compliance, there is a lot of room for us to continue to add value and growth in that area as well.
This is the big advantage for the major cloud infrastructure leaders. Not only is cloud infrastructure growing by leaps and bounds, but each company's ability to layer on other services in a one-stop shop for customers undergoing their cloud migrations is a huge advantage. I wouldn't be surprised to see Microsoft, like the other big cloud vendors, continue to outperform the market over the next five years, even as the company exceeds a $1 trillion market cap.