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Forget Azure: This Is Microsoft’s Highest-Growth Segment Right Now

By Billy Duberstein – Jul 24, 2020 at 9:00AM

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Microsoft’s earnings weren’t that surprising overall, but this segment smashed expectations.

For the past few years, the clear star of the Microsoft (MSFT 3.08%) empire has been its cloud segment, with its Azure infrastructure-as-a-service segment growing extremely fast, and its software-delivered-as-a-service segment helping the core Office and Dynamics brands achieve years of strong double-digit growth, despite their already large size.

However, in Microsoft's recent earnings release on July 22, which handily beat analyst expectations for revenue and earnings per share, an entirely different segment eclipsed cloud to take Microsoft's growth crown -- at least for now.

A young boy in glasses is surprised at something on his laptop.

Image source: Getty Images.

Xbox rules the June quarter

Microsoft's sometimes overlooked Xbox gaming segment took the crown in the quarter ended in June, powering the company's more personal computing segment to smash analyst expectations. Xbox grew a stunning 65% overall and 68% in constant currency, showing the remarkable demand for gaming during the lockdowns that began just before the quarter started. That growth marked a stark acceleration over the mere 2% growth Xbox saw in the March quarter. Xbox's blockbuster numbers managed to beat out Azure's 47% growth and 50% growth in constant currency in the June quarter.

Remarkably, even though Xbox will be launching a new console this holiday season, customers still raced out to buy the older version that's now at the end of the its lifecycle, with Xbox hardware up a stunning 49% during the quarter.

Though Microsoft doesn't break out gaming revenue specifically, strong gaming performance enabled the more personal computing segment, which groups Xbox with Windows, Surface, and the Bing search engine, to vastly outpace analyst expectations. That segment logged $12.91 billion in revenue, trouncing analyst expectations of $11.47 billion by a wide margin. That made up for a slight miss on the productivity and business process segment, which contains Office, Dynamics, and LinkedIn.

Looking ahead

Microsoft management said its Xbox Game Pass subscriptions saw record growth, and also announced it was attaching the new xCloud capability to Game Pass, which allows customers to stream games directly to their mobile phone or tablet. The company's Minecraft game, purchased in 2014, also achieved record monthly active users at 132 million. These results are occurring ahead of the release of the Xbox Series X this fall, which promises to launch with the largest lineup of games around any prior console release.

Microsoft isn't resting on its laurels either, as its hundreds of millions of users pale in comparison to the two billion-plus gamers all over the world. CEO Satya Nadella said as much on the conference call with analysts:

Going forward, Xbox with the approach we are taking has much more of an ability to reach the two-plus billion gamers out there and we are in the early days of building that out. And so, this quarter of course, will stand out for many of the reasons because of the remote nature of how a lot of the activity happened. But -- and also, we have a new console that's very much part of our strategy. But we go beyond the console to the PC. We go to mobile and we have the streaming service. So all of these accrue to what we think in the long run is going to be a much bigger addressable market and we have a great structural position. We have a social network in Xbox Live. Obviously, we have a store that monetizes super well, as well as, we have the Game Pass subscription.

Diversification pays off

Credit for Microsoft's recent success has justifiably gone to its Azure cloud computing division, but Microsoft is also much more than just Azure. The creation of Xbox and the acquisition of Minecraft in 2014 are sometimes overlooked parts of the Microsoft story. While other segments such as Office and LinkedIn came in a bit soft last quarter, due to obvious reasons around enterprise spending, Xbox added nice consumer-focused diversification to the Microsoft story beyond enterprise software.

With record low interest rates and lots of risk out there across many industries, the safety of having not one, but many, diverse profit centers is what has buoyed large-cap technology stocks like Microsoft, and I expect that trend to continue for the foreseeable future.

Look for the Xbox and the video gaming segment to get even more attention this winter as the new Xbox console launches in time for the holidays -- especially if we are still without a COVID-19 vaccine.

Teresa Kersten, an employee of LinkedIn, a Microsoft subsidiary, is a member of The Motley Fool's board of directors. Billy Duberstein owns shares of Microsoft and has the following options: short August 2020 $270 calls on Microsoft, short August 2020 $250 calls on Microsoft, and short August 2020 $170 puts on Microsoft. His clients may own shares of the companies mentioned. The Motley Fool owns shares of and recommends Microsoft and recommends the following options: long January 2021 $85 calls on Microsoft and short January 2021 $115 calls on Microsoft. The Motley Fool has a disclosure policy.

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