Microsoft Cloud Services Fuel Better-than-expected Earnings, But Outlook Weak – Recent earnings from cloud computing leaders suggest that underlying sales growth is strong and exceeding market expectations. Hyperscalers operating massive data centers are investing aggressively in building capacity in anticipation of an imminent increase in demand. Industry analysts such as Gartner expect growth in total spending on cloud-deployed solutions to reach 20% in 2022
. Meanwhile, shares of market-leading infrastructure and application vendors have declined significantly, with valuations challenging the fundamental growth of the entire business over the past two years. We believe this disruption could provide an opportunity for investors to capitalize on the sustainable growth of cloud computing as IT workloads favor operational flexibility, cost reduction, security and permanent off-shoring from the site.
Microsoft Cloud Services Fuel Better-than-expected Earnings, But Outlook Weak
Sixteen years ago, Amazon opened up its in-house designed modular IT system to anyone willing to pay to use it. The innovative model was designed to address the complexities facing modern Internet-scale consumer technology companies, as they typically struggle to add more servers, disks and networking equipment to accommodate explosive growth in users and d -data.
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This seemingly innocuous decision by Amazon catalyzed a new model of IT delivery, which is now called public cloud. The system was revolutionary because it did not require companies to spend upfront on servers or hardware, and was perfectly suited to a company’s processing and traffic needs. In the following years, businesses of all shapes and sizes, motivated by the clear advantages of cost and operational flexibility, rushed to take advantage of the benefits of the cloud. By 2021, global spending on cloud services will reach nearly $411 billion
At the same time, the cloud delivery model has overcome considerable skepticism about scalability, security and economic viability, with dedicated advances in computing, security, storage and networking . The biggest proof of this success is Netflix, one of the biggest internet platforms of the modern era. The company seamlessly delivers the largest library of on-demand content to more than 220 million subscribers and processes more than 125 million hours of views per day by running the majority of its infrastructure on the AWS platform of Amazon.
The discovery of Amazon and the strong margins of this business have attracted other major technology companies to the opportunity of partners. Microsoft, under new leadership, is reorienting itself to become a cloud-first software company. Alphabet, eager to diversify its empire away from digital advertising, used its email software line of business to start selling hosting services. IBM saw the cloud as an opportunity to supplement its decaying mainframe empire. Even the Chinese Internet giants have taken notice. By the mid-2010s, Tencent, Alibaba, and a number of other technology companies entered and increased the competition in the space. Hyperscalers responded by spending hundreds of billions to install giga-sized hosting facilities, computers and networks to allow traffic from IT buyers to flow through.
It was only when the COVID came knocking that cloud software really had the chance to show its amazing scalability and efficiency. This has allowed companies and governments to maintain some semblance of functionality even in the worst stages of lockdowns, while allowing greater user participation in the virtual world.
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Two years later, cloud computing shares are trading as if this phase of secular growth is over. For example, the constituents of the Indxx Global Cloud Computing index are trading at a trailing 12-month sales multiple (LTM) of 5.1x, down more than 40% from January 2020 levels .
Despite what the short-term market price action suggests, we believe the growth runway for cloud stocks is significantly longer. With rising rates and sufficient inflationary pressures, we expect the cloud’s efficiency, cost benefits, and lower total cost of ownership to feature prominently in corporate IT budgets. For the leading cloud companies, we believe these factors could accelerate growth in the coming years.
In 2021, hyperscalers and enterprise software majors took a cautious stance on the industry’s outlook, considering uncertain macroeconomic conditions and the persistent risk of COVID-19 and its variants.
Catalysts on the horizon, such as distributed work, distance learning, increased consumption of digital services, and cybersecurity threats, are emerging. But it was natural for large enterprise IT buyers to take their time to rethink new spending programs that match the needs of the COVID era. A resurgence of the virus can disrupt travel plans, hurt sales programs and de-prioritize software consumption in specific segments. In addition, the increase in corporate bankruptcies and the first signs of recession may push buyers further.
Microsoft’s Cloud Has Business Booming Again
Some of the fog has lifted as 4Q21 and full-year 2021 earnings numbers begin to emerge in early 2022. Major enterprise software companies reported significantly better-than-expected earnings, prompting them to raise their outlook for full-year 2022. This momentum continued into 1Q22 earnings. . In the most recently reported quarter, the constituents of the Indxx Global Cloud Computing Index experienced weighted average year-over-year growth of 22.3% year-over-year (yoy), an increase of 180 basis points (bps) year-over-year. year every year, as the following graph shows. Sales met average consensus expectations for the quarter by 1.5%.
Infrastructure-as-a-Service (IaaS) vendors led the rally. Amazon, Google, Microsoft, the three largest providers of public cloud infrastructure services exceeded expectations. Amazon’s flagship cloud empire, AWS, increased its top line by 37% year over year in Q1 to Q2 to total $18.4 billion in sales
. With this, Amazon made a whopping $67 billion in recurring 12-month sales across the segment. Microsoft Azure increased its top line by 46% year over year, keeping pace with average growth over the previous four quarters
. Google’s cloud platform reported strong numbers with more than 44% year-over-year growth and sales totaling $5.8 billion in the quarter.
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Management comments from the three major cloud players were equally positive. For example, Microsoft Azure said it almost doubled new deals signed to more than $100 million year-on-year, with big spenders such as Boeing, Kraft Heinz, US Bank and Westpac all moving in during the last quarter.
. The excellent prospects also translated into an increase in investments in dollars. The capital expenditure (capex) of the three players grew in the three months. Google increased capital raising by a record 64.7% year over year
. Amazon’s top rate is inflated by the rest of its e-commerce business, but is up 24%
, a significant portion of which will go to cloud data centers, especially since the company is withdrawing investments intended for the e-commerce business
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. Microsoft’s capital spending grew 5% year-on-year for Q1 22, but this is apart from 26.2% year-on-year growth in 2021 for full-year capital and 38.2% YoY in 2020
Another data point for the underlying momentum in the cloud space comes from tracking sales of data center segments for some major vendors for hyperscale data centers. At Intel, which primarily supplies x86-based processing units and field-programmable gate arrays (FPGAs) for AI training, data center segment revenue grew 22% year over year after a year in 1Q22 and quarterly sales reached 6 billion dollars
. This growth followed the segment’s 20% year-over-year growth in 4Q21. At Nvidia, the leading provider of data center GPUs to accelerate AI workloads, data center segment sales grew 83% year over year, with 15% sequentially
. AMD is a major supplier of EPYC processors for Microsoft’s AWS and Azure, with about a quarter of its total revenue coming from data center sales.
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The Application (SaaS) companies within the Global Cloud Computing Index Indxx posted an average higher surprise of 1.9% for the most recently reported quarter, increasing their top line on average by 18.3% over annual basis. In addition, vendors of hybrid cloud products and platforms, which lie at the intersection of infrastructure and SaaS, continued to show momentum. For example, IBM reported that hybrid cloud revenue, which includes Platform-as-a-Service (PaaS) products and software provider Red Hat, increased by 14%.
Industry estimates continue to paint a rosy outlook for the broader cloud market. Gartner Predicts Global Spending on Cloud Services to Grow Nearly 20% to $496 Billion in 2022
. In our view, spending is likely to exceed this projection, as it has consistently done over the past decade.
In total, global IT spending, including communications services, software, security, platforms and other non-hardware categories, exceeded nearly $3.6 trillion annually
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. We believe that the best part about cloud software is that its management can be outsourced. An organization’s focus can remain on resource utilization alone, which means no direct costs for rent, facilities, labor, maintenance, insurance, and other costs resulting from running IT b ‘self managed data centres. Typically, these operating costs can amount to a third of total IT spending
And, when added to total IT spending on systems, brings the total addressable market (TAM) of cloud technology to more than $4 trillion. With cloud services spending levels predicted to reach nearly $500 billion by 2022
, the market penetration will effectively be just under 15%, leaving enough runway for sustainable growth during this decade.
In this challenging macro environment, corporate fiscal discipline will be essential. Automation and low maintenance software can play a vital role in helping businesses remain resilient. During such times, the potential cost benefits of cloud services will be highlighted, as businesses can avoid purchasing expensive servers, racks and hosting contracts, freeing up valuable cash while still have access to the best software.
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Said that migrating more workloads to the cloud is one of the key strategic initiatives of the year, along with optimizing existing cloud spending. 42% said moving from on-premises software to SaaS was their top priority. The managers also indicated that they intend to increase