Mexico is an emerging market, but it's rarely mentioned in the same breath as higher-growth countries like China or India. The country's GDP growth decelerated over the past five years, and it's still struggling with poverty, crime, and corruption.
Yet there are flickers of hope on the horizon. The trade war between the U.S. and China caused some companies to move their manufacturing plants to Mexico to avoid tariffs. Mexico's poverty rates are also gradually receding, and its per capita income rose from $5,481 to $9,673 between 1998 and 2018.
That's why it wasn't surprising when Microsoft (NASDAQ:MSFT) recently announced that it would invest $1.1 billion in Mexico over the next five years. In a video released by the Mexican government, CEO Satya Nadella stated that Microsoft would build a new data center in Mexico and invest in new training labs and programs across the country.
Nadella, who met with Mexican president Andres Manuel Lopez Obrador last year, stated that the investment would expand "access to digital technology for people and organizations across the country." Let's dig deeper to see what Microsoft's investment tells us about its future plans for Latin America.
Why is Microsoft interested in Mexico?
Microsoft generated 51% of its revenue from the United States in fiscal 2019. The rest came from "other countries," but Microsoft doesn't break down its international sales by individual countries or regions. However, it noted that no country outside of the United States generated more than 10% of its revenue.
Mexico is the 15th-largest economy in the world, so it probably only accounts for a low single-digit percentage of Microsoft's annual revenue. Nonetheless, planting roots in Mexico could still benefit Microsoft in several ways.
First, it will expand the global presence of its cloud platform Azure, which is available in 56 regions and 140 countries worldwide. The majority of its data centers are concentrated in the U.S., Europe, Asia, and the Middle East. It only operates two data centers in Africa, and its single center in Latin America is located in Brazil.
Building a new data center in Mexico would significantly boost Azure's capacity in Latin America. Azure -- which generated 62% annual revenue growth last quarter -- is the core growth engine of Microsoft's commercial cloud unit, which grew its revenue 39% to $12.5 billion (34% of its top line) last quarter.
Microsoft could tether more Mexican businesses to Azure, which would widen its moat against its larger rival Amazon (NASDAQ:AMZN) Web Services (AWS). AWS currently offers three availability zones, all based in Brazil, for Latin America.
Microsoft could also bundle other commercial cloud services (like Office 365 and Dynamics 365) with Azure. Some of Azure's top customers, including Walmart (NYSE:WMT), also operate in Mexico -- so a regional data center could tighten Microsoft's grip on Walmart's Mexican businesses. Microsoft's investments in training labs could also produce skilled Mexican workers who could run its regional operations for lower wages than workers in other countries.
Microsoft could reap other benefits
Microsoft's investment in Mexico is considered a rare victory for President Lopez Obrador's left-wing administration, which was previously criticized for implementing rigid business regulations that stifled local and foreign investments. Neither Microsoft nor the Mexican government revealed the exact terms of the deal, but the tech giant could be receiving tax breaks or other benefits for setting up shop in Mexico.
$1.1 billion over a period of five years -- or $220 million a year -- is pocket change for Microsoft, which is expected to generate $142 billion in revenue this year. In short, it's a small price to pay to boost Azure's presence in Latin America, widen its moat against Amazon, and gain a firm foothold in an oft-overlooked emerging market.