Nadella, Hood Make a 3-Part Case for Azure's Future

Microsoft beat Wall Street estimates for both revenues and earnings in the latest financial quarter, and its stock price was riding more than 5% higher at mid-day Thursday in the wake of the previous evening's report.

While financial analysts on the Microsoft earnings call Wednesday evening were positive overall about the quarterly results, they asked CEO Satya Nadella and CFO Amy Hood repeatedly about the growth rate for Microsoft Azure and came at the issue from many different angles.

Azure revenues are up 76% over the year-ago quarter. That's impressive, especially considering Microsoft is starting from a relatively high number as the No. 2 public cloud provider after Amazon Web Services (AWS).

Yet the number is slightly worrying to financial analysts, who note that the Azure growth rate figure has been marching steadily downward over the last few years. By comparison, the growth rate for the same quarter a year ago was 90%; two years ago, it was 116% for the quarter.

Nadella and Hood together conjured an extremely positive story about Azure's future built on three major elements.

One element is that Microsoft's hybrid approach to the cloud is not only a strategic advantage, but that analysts should be thinking about it as effectively hiding some Azure revenues. Microsoft's unique attribute, compared to major public cloud competitors AWS or Google Cloud Platform, is that the company has a huge installed base of on-premises server software customers. That legacy encouraged Microsoft to focus more on hybrid solutions that allow customers to move workloads to the cloud at their own pace and to integrate all kinds of services between the on-premises servers and the cloud platform. Over the last year, Microsoft has moved to bring its licensing model in line with that hybrid approach, especially via Azure hybrid benefits.

Hood made that case in an answer to one analyst. "I tend to focus...on the 'all up' server and product [Key Performance Indicator] because the Azure hybrid benefits that exist with Windows Server and SQL Server are really valuable to customers if they want to move to Azure on their own terms," Hood said. "If we start to focus on one number or the other, I think we're missing the fact that our customer method and go-to-market is actually through the overall product portfolio."

Nadella hammered the theme home in response to a different question. "We don't think of hybrid as some stopgap in a move to the cloud," he said. "[It's] not just the old workloads but most importantly for new workloads, and that's where we're seeing some very significant good feedback loops in shaping even our future roadmap. And this is a place where we are leading."

Another basic element of Microsoft's Azure story is one of driving cost out of the platform. Hood said commercial cloud gross margin percentage increased 4 points to 62% driven by significant improvement in Azure gross margin. Nadella added that the margin improvements are crossing Microsoft's product boundaries as more of the infrastructure is unified. "For the first time, what you see across Microsoft is really one platform, which spans all of these businesses and all of the margin structures that are there represented in it," he said.

The other element is Microsoft's rapid buildout of Azure services. Nadella enumerated some of what he described as 100 new Azure capabilities introduced in the previous quarter (mostly at Microsoft Ignite), including Azure Confidential Computing, Azure Sphere and Azure Digital Twins. He pointed out that new and higher-level services should generate higher margins over time.

That three-part case -- that hybrid is a competitive strength that partially obscures some Azure revenues, that margins are improving and that rapid innovation around Azure capabilities promises more upside -- seemed for now to have satisfied investors, given the pop in Microsoft share prices.

Posted by Scott Bekker on 10/25/2018 at 12:00 PM