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This is turning out to be one of the worst quarters for technology companies in a long time. Most are missing estimates on multiple fronts, or managing to beat lowered expectations. One area that deserves special focus just because it has been so strong of late is the cloud. Alphabet (GOOGL - Free Report) , Microsoft (MSFT - Free Report) and Amazon (AMZN - Free Report) are three major players in the space. So management commentary coming out of their earnings calls tells us a lot about the state of the market.
It turns out that the general sentiment, near term challenges and long-term potential that the companies are seeing are very similar.
Alphabet’s management said on the call that “As companies globally are looking to drive efficiencies, Google Cloud's open infrastructure creates a valuable pathway to reduce IT costs and modernize.”
Microsoft said, “The way we see it is, overall, macro will mean that everybody is going to optimize their build. In fact... our job number one for large swaths of our sort of even customer-facing organizations is to proactively help them optimize. In fact, our incentives in our customer success teams are lined up with them, helping customers ‘do more with less.’
"So that's sort of one side. The thing, though, from a customer perspective, the best way for them to align their spend with what is uncertain demand is to move to the cloud. So we see the value prop of the cloud. So the big winner in all of this will be public cloud, because public cloud helps businesses offset the risk of taking demand risk.”
Amazon’s management also upheld this view: “We think the benefit of cloud computing is really showing up right now because we allow customers to turn what can normally be a fixed expense into a variable expense, and they can let us manage the highs and lows of inflation and other cost of electricity and everything else. So I think just like in 2020, these time periods are good for long-term adoption on cloud computing.”
However, while Alphabet’s cloud revenue in the just-reported quarter was better than expected, the others were not so lucky. The stronger dollar hurt all three, because of the volume of revenues generated overseas.
Alphabet said, “We are pleased with the ongoing momentum. It's across a wide range of industries and geographies. And it really comes back to the team's focus on helping them solve unique business issues and innovate in new areas as they digitally transform.”
But management’s tone about the near-term outlook was cautious, recalling what they said last quarter as well: “in some cases, certain customers are taking longer to decide, and some have committed to deals with shorter terms or smaller deal sizes, which we attribute to a more challenging macro environment. Some are impacted due to reasons that are specific to their business. But overall, as you can see from the results here again, we're pleased with the momentum in Cloud.”
While reiterating that the company continued “to see growth in the number of large long-term Azure and Microsoft 365 contracts across all deal sizes,” Microsoft’s management also said that they expect moderation in the 365 growth rate given the size of the installed base.
The other factor that impacted results in the last quarter is also expected to influence results in the current quarter: The lower-than-expected growth in Azure and other cloud services revenue was “driven by the continued moderation in Azure consumption growth, as we help customers optimize current workloads while they prioritize new workloads.” Hybrid demand continued to spur the on-premise server business with particular strength on the annuity side, ahead of the SQL Server 2022 launch.
Amazon attributed the last quarter’s performance to macro weakness. “With the ongoing macroeconomic uncertainties, we've seen an uptick in AWS customers focused on controlling costs. And we're proactively working to help customers cost optimize, just as we've done throughout AWS' history, especially in periods of economic uncertainty. The breadth and depth of our service offerings enable us to help them do things like move storage to lower-priced tiers options and shift workloads to our Graviton chips.”
Margins are also a concern for Amazon: “We're also seeing energy costs that are materially higher than they had in pre-pandemic, electricity and the impact of natural gas pricing. So those prices have up more than two times over the last couple of years and contribute to about 200 basis point degradation versus two years ago. So we're fighting through some of that as well, which is a new thing for the AWS business. But we'll continue to look for ways to optimize our operations to use less energy.”
Amazon also thinks there is considerable uncertainty in the short run: “The offset in the short run is that some companies have demand that drops. I think what was different in 2020 was there were companies that went down and there's companies that went up quite a bit that were servicing high volumes during the pandemic. So that dynamic is not in place right now, and I think everyone is just cautious and they want to, again, watch their spend.”
The Bottom Line
All three companies recognize the fact that this is an important time to bring new customers on board because of the cost efficiencies that the cloud can provide in times of macro uncertainty. The idea seems to be to get more customers in the door, even if they don’t commit to long-term agreements. There is a tremendous amount of confidence in the longer-term potential of the cloud because businesses and governments are still in the early days of public cloud adoption. This confidence is reflected in the significant capital they are investing in the business.
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What Is Happening in the Cloud?
This is turning out to be one of the worst quarters for technology companies in a long time. Most are missing estimates on multiple fronts, or managing to beat lowered expectations. One area that deserves special focus just because it has been so strong of late is the cloud. Alphabet (GOOGL - Free Report) , Microsoft (MSFT - Free Report) and Amazon (AMZN - Free Report) are three major players in the space. So management commentary coming out of their earnings calls tells us a lot about the state of the market.
It turns out that the general sentiment, near term challenges and long-term potential that the companies are seeing are very similar.
Alphabet’s management said on the call that “As companies globally are looking to drive efficiencies, Google Cloud's open infrastructure creates a valuable pathway to reduce IT costs and modernize.”
Microsoft said, “The way we see it is, overall, macro will mean that everybody is going to optimize their build. In fact... our job number one for large swaths of our sort of even customer-facing organizations is to proactively help them optimize. In fact, our incentives in our customer success teams are lined up with them, helping customers ‘do more with less.’
"So that's sort of one side. The thing, though, from a customer perspective, the best way for them to align their spend with what is uncertain demand is to move to the cloud. So we see the value prop of the cloud. So the big winner in all of this will be public cloud, because public cloud helps businesses offset the risk of taking demand risk.”
Amazon’s management also upheld this view: “We think the benefit of cloud computing is really showing up right now because we allow customers to turn what can normally be a fixed expense into a variable expense, and they can let us manage the highs and lows of inflation and other cost of electricity and everything else. So I think just like in 2020, these time periods are good for long-term adoption on cloud computing.”
However, while Alphabet’s cloud revenue in the just-reported quarter was better than expected, the others were not so lucky. The stronger dollar hurt all three, because of the volume of revenues generated overseas.
Alphabet said, “We are pleased with the ongoing momentum. It's across a wide range of industries and geographies. And it really comes back to the team's focus on helping them solve unique business issues and innovate in new areas as they digitally transform.”
But management’s tone about the near-term outlook was cautious, recalling what they said last quarter as well: “in some cases, certain customers are taking longer to decide, and some have committed to deals with shorter terms or smaller deal sizes, which we attribute to a more challenging macro environment. Some are impacted due to reasons that are specific to their business. But overall, as you can see from the results here again, we're pleased with the momentum in Cloud.”
While reiterating that the company continued “to see growth in the number of large long-term Azure and Microsoft 365 contracts across all deal sizes,” Microsoft’s management also said that they expect moderation in the 365 growth rate given the size of the installed base.
The other factor that impacted results in the last quarter is also expected to influence results in the current quarter: The lower-than-expected growth in Azure and other cloud services revenue was “driven by the continued moderation in Azure consumption growth, as we help customers optimize current workloads while they prioritize new workloads.” Hybrid demand continued to spur the on-premise server business with particular strength on the annuity side, ahead of the SQL Server 2022 launch.
Amazon attributed the last quarter’s performance to macro weakness. “With the ongoing macroeconomic uncertainties, we've seen an uptick in AWS customers focused on controlling costs. And we're proactively working to help customers cost optimize, just as we've done throughout AWS' history, especially in periods of economic uncertainty. The breadth and depth of our service offerings enable us to help them do things like move storage to lower-priced tiers options and shift workloads to our Graviton chips.”
Margins are also a concern for Amazon: “We're also seeing energy costs that are materially higher than they had in pre-pandemic, electricity and the impact of natural gas pricing. So those prices have up more than two times over the last couple of years and contribute to about 200 basis point degradation versus two years ago. So we're fighting through some of that as well, which is a new thing for the AWS business. But we'll continue to look for ways to optimize our operations to use less energy.”
Amazon also thinks there is considerable uncertainty in the short run: “The offset in the short run is that some companies have demand that drops. I think what was different in 2020 was there were companies that went down and there's companies that went up quite a bit that were servicing high volumes during the pandemic. So that dynamic is not in place right now, and I think everyone is just cautious and they want to, again, watch their spend.”
The Bottom Line
All three companies recognize the fact that this is an important time to bring new customers on board because of the cost efficiencies that the cloud can provide in times of macro uncertainty. The idea seems to be to get more customers in the door, even if they don’t commit to long-term agreements. There is a tremendous amount of confidence in the longer-term potential of the cloud because businesses and governments are still in the early days of public cloud adoption. This confidence is reflected in the significant capital they are investing in the business.
One-Month Price Performance
Image Source: Zacks Investment Research