Microsoft (MSFT -0.11%) stock has been under pressure since the technology giant released its fiscal 2023 fourth-quarter results (for the quarter ended June 30) on July 25, driven mainly by concerns regarding the momentum of its cloud business.
Though Microsoft's revenue and earnings rose year over year and landed ahead of Wall Street's expectations, the 26% year-over-year growth in the Azure cloud services division was a tad slower than the 27% revenue growth this segment recorded in the fiscal third quarter. Given that cloud computing is Microsoft's fastest-growing business, any sign of a slowdown in this segment isn't going to sit well with investors.
It is worth noting that the growth rate of Azure and other cloud services decelerated from 40% in the fourth quarter of fiscal 2023. Also, sales of the company's server products and other cloud services fell to 17% last quarter from the 22% year-over-year growth in this segment in the year-ago period.
Overall, Microsoft's revenue from the intelligent cloud business, including from Azure and other cloud-related products and services, grew 17% in fiscal 2023 to $88 billion.
This segment produced 41% of Microsoft's total revenue of $212 billion, and its robust growth led to a 7% year-over-year jump in the company's top line. However, the intelligent cloud segment's revenue grew at a much faster pace of 25% in fiscal 2022.
Not surprisingly, investors are worried about Microsoft's prospects as one of its most important growth drivers is losing momentum. But then, there is one catalyst that could ignite the growth of Microsoft's cloud business and send the stock soaring.
Artificial intelligence could supercharge Microsoft's cloud business
The growing proliferation of artificial intelligence (AI) will be a long-term tailwind for Microsoft. Mordor Intelligence estimates that the cloud AI market could clock annual growth of 32% over the next five years, generating annual revenue of $207 billion in 2028 compared to this year's estimated $51 billion.
The market's rapid growth is expected to be driven by an increase in companies and enterprises looking to integrate AI into their operations. The good part is that Microsoft is already on track to take advantage of this huge opportunity with its Azure OpenAI Service, which gives enterprises and organizations access to large language models (LLMs) such as GPT-4, GPT-3, Codex, and DALL-E.
These LLMs allow users to generate content, images, and code and create custom models for generating contextual search results and natural language processing, among other tasks.
This AI cloud service from Microsoft is already witnessing healthy traction among customers. According to CEO Satya Nadella on the latest earnings conference call: "We have great momentum across Azure OpenAI Service. More than 11,000 organizations across industries, including IKEA, Volvo Group, Zurich Insurance, as well as digital natives like Flipkart, Humane, Kahoot, Miro, Typeface, use the service."
To put things in perspective, Nadella points out that Azure OpenAI added close to 100 customers every day last quarter. This includes Mercedes-Benz, which is deploying ChatGPT via Azure OpenAI in 900,000 vehicles in the U.S. to make its in-car voice assistant smarter. Moody's, on the other hand, is relying on Microsoft's Copilot AI platform to improve employee productivity.
Microsoft management says that the company is "partnering broadly to scale this next generation of AI to more customers," so it won't be surprising to see more companies opt for the Azure OpenAI cloud service. It is also worth noting that the growing interest in Microsoft's cloud-based AI solutions helped the company record the highest-ever average annualized value for its large long-term Azure contracts.
These developments suggest Microsoft is in a position to make the most of the long-term opportunity available in the cloud AI market.
Azure controlled 22% of the cloud infrastructure market in the second quarter of 2023, according to Synergy Research Group. Amazon is the leading player in this market, with a 32% share. However, Microsoft claims it enjoys the top position in cloud-based AI workloads, indicating it may be commanding a higher market share in this nascent but lucrative niche.
That won't be surprising, given that the company was an early mover into this space with OpenAI's ChatGPT last year, and it moved quickly to monetize its AI development efforts. Assuming Microsoft ends up controlling 30% of cloud-based AI workloads by 2028, it could see a $60 billion annual bump in its top line, based on Mordor Intelligence's forecast of how big this space is expected to become in five years.
Of course, AI is also giving Microsoft a boost in other areas, such as office productivity and collaboration tools. So the overall impact of AI on Microsoft's business is likely to be much greater in the long run.
Stronger growth could push Microsoft into the $3 trillion club
In the recently concluded fiscal year, Microsoft's revenue increased 7% to $212 billion. But catalysts such as AI will likely accelerate the company's growth into the double digits from the current fiscal year.
MSFT Revenue Estimates for Current Fiscal Year data by YCharts.
The chart above suggests that Microsoft's revenue growth is set to improve with each passing year for the next three fiscal years. Assuming Microsoft hits the $304 billion revenue estimate in fiscal 2026, its market cap could increase to well over $3 trillion based on its five-year average price-to-sales ratio of 10.3.
That's why investors would do well to focus on the bigger picture and consider taking advantage of the recent weakness in shares of Microsoft as it stands to win big from AI in the long run.
