Microsoft (NASDAQ:MSFT) and IBM (NYSE:IBM) both posted mixed earnings results in their most recent quarters. Microsoft's fourth-quarter revenue and earnings growth topped analyst estimates, but its bottom line took a big hit from restructuring charges and sluggish demand for its older software products. IBM posted its 13th consecutive quarter of declining revenue, missing analyst estimates, although its adjusted earnings beat expectations.
Yet both Microsoft and IBM have repeatedly told investors that their growing cloud businesses will eventually offset weaker performance in their older businesses. Therefore, let's check in on both companies' cloud growth to see if either one can achieve that goal.
Microsoft: $20 billion by 2018
Back in April, Microsoft CEO Satya Nadella claimed that his company would generate $20 billion in annual cloud revenue by the end of fiscal 2018. That would have been good for 21% of its revenue in fiscal 2015.
Last quarter, Microsoft's commercial cloud revenue rose 88% year over year, achieving an annual run rate of over $8 billion. That's a notable slowdown from the triple-digit growth it posted in the previous four quarters, but if Microsoft achieves just 40% annual growth going forward, it would hit $22 billion by 2018.
Microsoft's cloud business consists of three main parts: Office 365, Dynamics CRM, and Azure, a cloud-computing platform that competes against IBM's BlueMix and Amazon's AWS. At the end of last quarter, Office 365 had 15 million subscribers on the consumer side, with nearly 1 million new customers signing up monthly. Fifty thousand new small- to medium-sized business customers were adopting Office 365 monthly, while the iOS and Android versions were downloaded over 150 million times. Dynamics CRM revenue rose 6% annually, while its online install base more than doubled.
Meanwhile, Azure combines a PaaS (platform as a service) platform with an IaaS (infrastructure as a service) platform. PaaS enables businesses to develop apps in the cloud, while IaaS provides remote storage and processing power to businesses through virtual data centers.
Deutsche Bank estimated in April that Azure only generated between $500 million and $700 million in annual revenue. But during the fourth-quarter conference call, Nadella claimed that both Azure's annual revenue and its usage had risen "by triple digits year-over-year," indicating that the platform could soon be generating $1 billion to $2 billion in annual revenue.
IBM: Focus on "strategic imperatives"
Last quarter, IBM reported that its cloud revenue rose more than 50% annually with an annual run rate of $8.7 billion. However, revenue for its cloud "as a service" offerings, which compete directly against Microsoft's cloud business, only had a run rate of $4.5 billion.
The heart of IBM's cloud as a service business is Bluemix, which is a hybrid PaaS/IaaS platform like Azure and AWS. Bluemix is linked to Watson, IBM's AI platform, which assists with advanced bulk processing features like machine learning and data analytics. The service also connects to the enterprise apps that IBM is developing for iOS devices.
The cloud is one of IBM's five "strategic imperatives," which also include its data analytics, mobile, social, and security businesses. Last year, revenue from those business units rose 16% annually and accounted for 27% of IBM's top line. In the first half of 2015, strategic imperatives revenue rose 30% annually, versus 20% growth a year ago. The company expects revenue from strategic imperatives to reach $40 billion by fiscal 2018, which would account for 44% of its projected annual revenue at that point.
While that sounds like a solid plan, investors should remember that the strategic imperatives businesses aren't reported separately on a quarterly basis. Instead, they're still tangled with IBM's core software and hardware business segments, which all posted annual revenue declines last quarter. Therefore, it's unclear if IBM's growth in strategic imperatives can fully offset future revenue declines across its other businesses.
The winner: Microsoft
As a cloud-focused investment, Microsoft has several advantages over IBM. First, Microsoft can leverage its 90%+ market share in PCs to tether more users to its commercial cloud services. By comparison, IBM must rely on its presence in IT services, where it's losing ground to nimbler rivals. Second, Microsoft's cloud business is growing at a faster rate than IBM's, and its "cloud as a service" segment generates more annual revenue than IBM's comparable services.
Looking ahead, investors should keep an eye on the cloud, but realize that it isn't a magic bullet that can fix all of Microsoft's and IBM's problems. Microsoft needs to address sluggish PC demand and weakness in mobile first, while IBM needs to strike back at its hungry competitors in the IT services, software, and hardware businesses.