Microsoft's AI Bet: Massive Investment and Growth Challenges

Author: Zhang Yifan

Editor: Shen Siqi

Source: Hard AI

Overall, Microsoft's revenue and profit in 2024Q2 basically met expectations. The AI business showed significant growth, with AI contributing $1.683 billion in cloud revenue this quarter, a 26% increase from the previous quarter; Office Copilot saw a 60% increase in customer growth and a doubling of daily active users. The company's capital expenditure this quarter significantly exceeded expectations, reflecting confidence in the growth of the AI business.

However, despite the strong growth of the AI business, the overall revenue growth rate of the company declined by 1.8 percentage points. The company explained this with two main reasons: 1) European demand in the second quarter was lower than expected; 2) the company's data center capacity was insufficient to meet the rapidly growing market demand.

In addition, new commercial orders this quarter only increased by 17% year-on-year, a 12% decrease from the previous quarter (2024Q1) growth of 29%. While it is currently difficult to determine whether this quarter's fluctuations are due to weakened incremental demand or simply seasonal fluctuations, the slowdown in revenue growth and weakening leading indicators are cause for concern.

Specifically:

1. Revenue and profit basically met expectations, but year-on-year growth rate declined: Revenue was $64.8 billion, a 15% year-on-year increase (17% year-on-year increase in the previous quarter), slightly exceeding the consensus expectation of $64.5 billion; net profit was $22.036 billion, a 9.5% year-on-year increase (20% year-on-year increase in the previous quarter), slightly exceeding the consensus expectation of $22 billion.

2. Capital expenditure significantly exceeded expectations: Capital expenditure this quarter reached $19 billion (compared to $14 billion in the previous quarter), far surpassing the consensus expectation of $15 billion. Expenditures related to cloud computing and artificial intelligence accounted for almost all of the capital expenditure, with about half used for building and leasing data centers, and the remaining portion mainly used for purchasing servers. The company expects capital expenditure to continue to grow in the next quarter, driven by the growth in cloud computing and artificial intelligence demand, as well as existing artificial intelligence capacity constraints.

3. Revenue from the three major business segments basically met expectations: Intelligent Cloud business revenue was $28.5 billion (expected $28.7 billion), a 19% year-on-year increase; Productivity and Business Processes business revenue was $20.3 billion (expected $20.2 billion), an 11% year-on-year increase; Personal Computing business revenue was $15.9 billion (expected $15.5 billion), a 14% year-on-year increase.

4. In terms of cloud business, AI contributed to revenue growth: AI contributed $1.683 billion in cloud revenue this quarter (compared to $1.332 billion in the previous quarter), a 26% increase quarter-on-quarter (compared to 22% in the previous quarter), with AI accounting for 8% of Azure revenue (compared to 7% in the previous quarter). Overall, revenue and proportion of AI in cloud business continue to grow.

5. AI growth, but Azure's year-on-year growth rate declined: While AI continues to grow in the cloud business, the overall Azure business saw a decline in year-on-year growth this quarter. Azure revenue this quarter was $21 billion, a 29% year-on-year increase (compared to 31% in the previous quarter). The main reasons are slightly lower growth in some European regions and Microsoft's infrastructure capacity constraints, which have not fully met market demandDespite a weakening demand from some European companies this quarter, the company stated that the AI market is overall in short supply, with Azure revenue expected to grow by 28-29% next quarter.

6. Concerns arise as year-on-year growth rate of commercial orders declines: This quarter, new commercial orders only grew by 17% year-on-year, a 12% decrease from the growth of 29% in the previous quarter (2024Q1). While it is currently unclear whether this quarter's fluctuation is due to a weakening incremental demand or simply seasonal fluctuations, the slowing revenue growth and weakening leading indicators are causing concerns.

7. Impressive growth of Github Copilot: Since its launch, in just over two years, over 77,000 organizations have adopted Github Copilot, representing a 180% year-on-year growth. Copilot is driving growth for GitHub, with GitHub's annual revenue now reaching $2 billion. This year, Copilot accounts for over 40% of GitHub's revenue growth, surpassing the scale of the entire GitHub at the time of acquisition.

8. Significant growth in Office AI business: Office Copilot's customer base grew by 60% month-on-month, with daily active users doubling. The number of customers with over 10,000 seats more than doubled month-on-month, including Capital Group, Disney, Dow Chemical, etc., with EY alone deploying Copilot to its 150,000 employees.

9. Gaming business (Xbox) sees a 61% year-on-year growth: Following the acquisition of Activision Blizzard, Xbox has seen over 60% year-on-year growth for the third consecutive quarter. This quarter, Xbox revenue grew by 61%, with the net impact of the Activision Blizzard acquisition accounting for approximately 58 percentage points. The company expects Xbox revenue growth to be around 50% in the next quarter, primarily driven by the net impact of the Activision acquisition.

10. Fiscal year 2025 guidance: Double-digit revenue growth, double-digit operating profit growth, and a 1% decrease in operating profit margin (consistent with the guidance from the previous quarter).

11. Dividends and buybacks remain largely unchanged from the previous quarter: Announced a dividend of $0.75 per share, with $4.21 billion spent on stock buybacks in the second quarter.

I. Financial Performance of Microsoft in 2024Q2

1. Revenue was $64.8 billion, a 15% year-on-year increase (compared to a 17% year-on-year increase in the previous quarter), exceeding the consensus expectation of $64.5 billion;

2. Net profit was $22.036 billion, a 9.5% year-on-year increase (compared to a 20% year-on-year increase in the previous quarter), slightly surpassing the consensus expectation of $22 billion;

Overall, while revenue and net profit slightly exceeded market consensus expectations, the growth rates declined compared to the previous quarterFY25 Guidance: Double-digit revenue growth, double-digit operating profit growth, 1% decrease in operating profit margin (consistent with the previous quarter's guidance).

Regarding dividends and buybacks, it remains largely unchanged from the previous quarter. Announced a dividend of $0.75 per share, with a second-quarter stock buyback amount of $4.21 billion.

II. 2024Q2 Microsoft Segment Revenue

1. Intelligent Cloud Business: Revenue of $28.5 billion, a year-on-year growth of 19%, slightly lower than the market's expected $28.7 billion.

• The growth rate of the cloud business declined from the previous quarter, mainly due to slightly lower growth in some European regions in June; and Microsoft's infrastructure capacity constraints, which did not fully meet market demand;

• Revenue from AI in the cloud business and the proportion of AI continued to grow;

2. Productivity and Business Processes: Revenue of $20.3 billion, a year-on-year growth of 11%, slightly higher than the market's expected $20.2 billion.

• After AI empowerment (Copilot), there was no significant growth in Office revenue;

3. Personal Computing Business: Revenue of $15.9 billion, a year-on-year growth of 14%, slightly higher than the market's expected $15.5 billion.

• Windows OEM growth rate decreased from the previous quarter, the PC market has not yet seen a recovery, and there is no significant growth from AI PC products yet;

• Revenue from Xbox content and services increased by 61%, with the net impact of the Activision Blizzard acquisition accounting for approximately 58 percentage points;

• Search and advertising business continued to grow under AI empowerment, with revenue growing by 19% year-on-year this quarter;

Q3 FY24 Segment Guidance: Intelligent Cloud revenue to grow by 18-20% year-on-year (Azure guidance +28%-29% cc), Productivity and Business revenue to grow by 10-11% year-on-year (Office 365 Commercial guidance +14% cc), Personal Computing revenue to grow by 9-12% year-on-year (Xbox guidance 50-55% cc).

III. 2024Q2 Microsoft Earnings Call

1. Cloud Business: Expanded data center layout, announced investments in four continents. These are long-term assets spread globally that will drive growth for the next decade and beyond. With over 60,000 Azure AI customers, a nearly 60% year-on-year growth, and continued growth in average spending per customer. The number of Azure AI customers using data analytics tools grew by nearly 50% year-on-year. Copilot is driving growth for GitHub, with GitHub's annual revenue now exceeding $2 billion. This year, Copilot accounts for over 40% of GitHub's revenue growth2. Productivity and Workflow Business: Office Copilot's customer base increased by 60% month-on-month, with daily active users doubling. The number of customers with over 10,000 seats more than doubled, including Capital Group, Disney, Dow Chemical, etc. EY alone deployed Copilot to its 150,000 employees.

3. Personal Computing Business: In terms of PCs, a new category of Copilot+ PC was launched this quarter, with a 50% year-on-year growth in active devices on Windows 11; on LinkedIn, the number of members is growing rapidly, with 1.5 million pieces of content shared on the platform every minute. Currently, video is the fastest-growing format on LinkedIn, with a 34% year-on-year increase in uploads; in gaming, driven by the acquisition of Activision Blizzard, Xbox content and services revenue grew by 61%, now having over 500 million monthly active gaming users on all platforms and devices; in search and advertising, revenue grew by 19% year-on-year this quarter, driven by AI.

4. Security Business: Now with over 1.2 million security customers, and Defender for Cloud (cloud security solution) generated over $1 billion in revenue in the past 12 months.

5. Performance Guidance: In the next quarter, Intelligent Cloud revenue is expected to grow by 18-20% year-on-year (with Azure guidance at +28%-29% cc), Productivity and Business Processes to grow by 10-11% year-on-year (with Office 365 Commercial guidance at +14% cc), and Personal Computing guidance to grow by 9-12% year-on-year (with Xbox guidance at 50-55% cc).

Microsoft Performance Analysis for 2024Q2

1. Revenue and Profit: Revenue was $64.8 billion, a 15% year-on-year growth (17% growth in the previous quarter), slightly exceeding the consensus expectation of $64.5 billion; net profit was $22.036 billion, a 9.5% year-on-year growth (20% growth in the previous quarter), slightly exceeding the consensus expectation of $22 billion. Overall, revenue and profit met consensus expectations, but the year-on-year growth rate decreased. This was mainly due to slightly lower-than-expected Azure growth in some European regions this quarter, as well as capacity constraints in Microsoft data centers. The decrease in profit growth rate was partly due to a significant increase in capital expenditure.

2. Operating Costs and Operating Profit Margin: The company continues to optimize operating costs, with the operating profit margin showing an overall upward trend, reaching 43.1% this quarter. For the next quarter, the company expects operating costs to be $19.95-20.15 billion (compared to $19.684 billion this quarter). This estimated figure includes approximately $700 million in costs related to the Activision Blizzard acquisition. Excluding these costs, operating costs for the next quarter are expected to be between $19.25 billion and $19.45 billionReasons for the increase in operating costs: 1) Growth in AI infrastructure investment; 2) Acquisition and integration of Activision Blizzard.

3. Capital Expenditure: Capital expenditure for this quarter reached $19 billion (compared to $14 billion in the previous quarter), significantly exceeding the consensus expectation of $15 billion. Almost all of the capital expenditure related to cloud computing and artificial intelligence, with approximately half used for building and leasing data centers, and the remaining portion mainly used for purchasing servers. The company expects capital expenditure to continue to grow quarter over quarter in the next quarter, driven by the increasing demand for cloud computing and artificial intelligence, as well as existing artificial intelligence capacity constraints.

Capex Outlook: It is expected that Capex for the fiscal year 2025 will be higher than the fiscal year 2024, continuing to invest in cloud computing and artificial intelligence infrastructure to meet the growing market demand.

4. Commercial Orders: Driven by AI, new commercial orders in this quarter only grew by 17%, or 19% when calculated at fixed exchange rates. This is mainly due to the growth in the number of contracts over $10 million and over $100 million for Azure and Microsoft 365. However, this growth rate is 12% lower than the 29% growth in the previous quarter. While it is currently unclear whether the fluctuations in this quarter are due to weakened incremental demand or simply seasonal fluctuations, concerns arise as revenue growth slows down in this quarter, and leading indicators also weaken.

Meanwhile, the backlog of unfulfilled commercial orders (deferred revenue from payments received but not yet recognized + amounts from contracts signed but payments not yet received) increased by 20%, or 21% when calculated at fixed exchange rates, reaching $269 billion.

5. Segment Revenue: Revenue is generally in line with expectations. Intelligent cloud business revenue was $28.5 billion (expected $28.7 billion), a 19% year-on-year growth; Productivity and Business Processes revenue was $20.3 billion (expected $20.2 billion), an 11% year-on-year growth; Personal Computing business revenue was $15.9 billion (expected $15.5 billion), a 14% year-on-year growth.

6. Productivity and Business Processes: Revenue was $20.3 billion, an 11% year-on-year increase, slightly higher than the market's expected $20.2 billion. After AI empowerment (Copilot), Office revenue did not show significant growth.

7. Personal Computing: Revenue was $15.9 billion, a 14% year-on-year increase, slightly higher than the market's expected $15.5 billion.

• Windows OEM growth rate declined from the previous quarter, as the PC market has not yet seen a recovery, and there is no significant growth from AI PC products yet.

• Revenue from Xbox content and services increased by 61%, with the net impact of the Activision Blizzard acquisition accounting for approximately 58 percentage points.

• Search and advertising business continued to grow under AI empowerment, with revenue increasing by 19% year-on-year this quarter.

8. Intelligent Cloud: Revenue was $28.5 billion, a 19% year-on-year increase, slightly lower than the market's expected $28.7 billion.

• Cloud business growth rate declined from the previous quarter, mainly due to slightly lower-than-expected growth in some European regions in June; and the capacity constraints of Microsoft's infrastructure, which cannot fully meet market demand.

• Revenue from AI in cloud business and the proportion of AI continued to grow.