Microsoft Q2 2024 Earnings Preview: 5 Things To Know
Bank of America put Microsoft’s second quarter revenue at $60.9 billion, up 15 percent year over year ignoring foreign exchange rates.
Generative artificial intelligence, Azure and other cloud offerings plus the security portfolio are all topics that could come up when tech giant Microsoft reports results for the second quarter of its 2024 fiscal year Tuesday.
Tuesday’s results – covering the quarter ended Dec. 31 – come as multiple investment firms report positive feelings toward Redmond, Wash.-based Microsoft’s GenAI and cloud opportunities, plus some optimism around IT spending.
In a January report, Bank of America put Microsoft’s second quarter revenue at $60.9 billion, up 15 percent year over year ignoring foreign exchange rates, and with a 1 percent upside “from continued Azure and M365 strength, though somewhat offset by weaker” PC shipments in the last quarter of the 2023 calendar year.
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Microsoft Q2 Preview
The firm predicted rate cuts starting in March, “which may provide a positive catalyst for the high-growth software sector, but software is not inexpensive after jumping 58 percent in 2023 and it's likely too soon to be a blind bull while we remain in the early-recovery phase of the business cycle.”
And Bank of America was positive on Microsoft for the year, saying that the vendor “represents a solid reacceleration story in 2024, fueled by core Office/M365 and Azure franchises.”
In a January report, Morgan Stanley called AI, process automation, security software and enterprise resource planning (ERP) applications the most defensive IT projects, a long-term positive for Microsoft.
The firm also said that while it is early days for revenue from generative AI, Wall Street and investors tend “to underestimate the size of new markets,” with Wall Street underestimating the size of the PC, internet, mobile and cloud opportunity by an average of 38 percent, looking at past data.
In a January report from Wedbush, the firm was optimistic in “an uptick in demand around enterprise software, cyber security, and a clear surge in demand around major AI projects and use cases exploding for 2024,” with less caution from CIOs than three months ago.
However, Wedbush noted a “spot of weakness on SMB and some longer sales cycles detected” – with the small and midsize business market a key one for the channel.
Wedbush also predicted “unprecedented spending and demand for the 2nd/3rd/4th derivatives of AI across the software, chip, and hardware ecosystem” as customers fear delays from chip shortages.
In a January report from Bernstein based on conversations with Microsoft executives, the investment firm said that Microsoft “sees continued cautiousness in the spending environment even though they see AI driving more top of the funnel interest in Azure.”
Here’s what else to look for heading into Microsoft’s second fiscal quarter earnings call.
Signs Of A Microsoft AI Revenue Boon?
A January report from Morgan Stanley said the firm expects “limited quantification of GenAI contribution in Q2” and no “breakout for future guidance.”
Conversations with channel partners plus results from a survey of CIOs left Morgan Stanley feeling that “Microsoft's strong positioning for GenAI (is) getting even stronger.”
Some of the more eye-catching AI-related results from Morgan Stanley’s survey include:
- 63 percent of CIOs expect to use Microsoft GenAI products over the next 12 months, with Azure OpenAI Services and Microsoft 365 Copilot screening as the most popular
- 68 percent of CIOs indicated direct impacts to investment priorities surrounding AI and machine learning (ML) technologies
- AI/ML emerged as CIOs’ No. 1 IT priority, up from No. 3 in the third quarter
- 38 percent of CIOs expect to use Microsoft 365 Copilot within the next 12 months
- 53 percent of CIOs expect to use Microsoft 365 Copilot in three years
- 37 percent plan to use Azure OpenAI Services
- 17 percent of CIOs expect to use Microsoft’s GitHub Copilot GenAI tool in the next 12 months
- 29 percent of CIOs indicate funding AI ventures through net new IT budget dollars
- 14 percent cite the reallocation from other areas of existing IT budget, with data center build outs, storage software and process automation projects most affected
Morgan Stanley put the Office Commercial Copilot opportunity at about $10 billion thanks to recently expanded ways for customers to buy the GenAI tool through solution providers – increasing from $8 billion.
Dropping the 300 seat minimum purchase requirement expanded the target seat base to about 193 million, up from 160 million. Morgan Stanley estimates that target is made of about 178 million E3 and E5 subscribers and about 15 million Business Standard and Premium users. The firm expects 20 percent Copilot seat penetration with $252 a seat.
The firm sees about $1 billion in opportunity for Microsoft 365 Consumer Copilot, double the prior estimate. Morgan Stanley expects a 5 percent penetration rate of an installed base of 83 million seats.
In a January report from Bernstein, the firm said that because Microsoft 365 Copilot only became generally available (GA) in November, “it is unlikely that most companies have included any meaningful number of M365 seats in CY24 budgets.”
Microsoft executives suggested to Bernstein a vendor consolidation argument for Microsoft AI. “Clients that are more Microsoft centric (especially leveraging all of M365 functionality) will see the quickest time to value,” Bernstein said in the report. “Microsoft explained that the more people within an organization that are using M365 Copilot, especially within the same department and with the same / similar jobs, the better the results.”
A January report from Bernstein based on conversations with Microsoft executives said “opportunities in commercial and cloud businesses will be central to the company’s future — plus an additional boost from AI as time goes on.”
“Microsoft has multiple irons in the fire, giving it a lot of cushion and avenues for growth,” according to Bernstein. “In our view, it is best-placed in software to capture longer-term upside from AI, and while much of the AI benefits are more longer-term, we believe the company’s strength in AI will add tailwinds to growth faster than expected.”
Microsoft Cloud, Azure Growth
The Morgan Stanley CIOs survey showed some positive measures for Microsoft’s cloud business and cloud overall
- CIOs estimated 36 percent of application workloads reside in the cloud today
- Microsoft widened its lead as the No. 1 share gainer of IT wallet as a result of shift to the cloud on a one-year and three-year view
- CIOs expect cloud adoption to continue, with 33 percent of workloads in cloud today increasing to 53 percent by 2026
- Among domain experts using or planning to use the Azure platform, 48 percent of application workloads are hosted in Azure today and should expand to 50 percent of workloads over the next three years
- With AWS, users said 27 percent of workloads are hosted on the platform today and could contract to 25 percent over the next three years
Although 9 percent of surveyed CIOs said they intend to downgrade subscription tiers within the next year – up from 8 percent in the second quarter of 2023 – and 4 percent plan to downgrade from E5 to the less expensive E3, Morgan Stanley did uncover some positive motion in the effort to motivate customers to upgrade subscription tiers.
The survey showed that 12 percent of CIOs expected to upgrade subscription tiers within the next year – up from 4 percent in the second quarter of 2023 – regardless of current starting tier, with most planning to upgrade from E3 to E5 next year.
For the second fiscal quarter, Morgan Stanley predicted Azure growth of 26.5 percent year over year, in line with Microsoft’s guidance and a deceleration from 28 percent the prior quarter and 27 percent the fourth fiscal quarter.
“Medium and long-term durability of growth is driven by ramping contribution from Azure AI Services, a waning intensity of Cloud optimizations, rebounding expectations for cloud migrations, long-term Azure deals going into production, Microsoft's intensifying focus on cloud verticalization, strong positioning for the rise in AI/ML use cases and a Microsoft 365 sales motion to support the seat-based/SaaS Azure workloads,” according to the Morgan Stanley report.
Morgan Stanley predicted Microsoft Cloud as a whole – Azure plus Office 365 Commercial plus Dynamics 365 plus LinkedIn Commercial – to grow about 22 percent year over year, a slight deceleration from 23 percent the prior quarter. For Office 365 Commercial growth, Morgan Stanley predicts about 16 percent growth year over year, a slight deceleration from 17 percent the prior quarter.
“The biggest risk we see is the potential for lack of data points on the Office 365 Copilot launch and overall we look for more meaningful contribution from copilot in 2H and FY25,” according to the report.
For the second fiscal quarter, Bank of America predicted growth of 12 percent year over year, $18.6 billion in revenue, for the productivity and business processes segment – which includes Office Commercial, Office Consumer, LinkedIn and Dynamics – with $450 million upside.
Microsoft executives told Bernstein that Azure growth should “be stable through the end of their fiscal year” with two prior quarters and the next three quarters marking “the longest period of stability” for Azure.
A negative from the meetings was that the executives told Bernstein that Microsoft will not always give AI as a percent of Azure growth because Azure AI is “so tightly intertwined with other Azure revenue streams.”
“The reason, we understand, is that an AI workload does not just use GPUs — it normally requires compute, storage, and PaaS services (e.g. app development, database, and much more),” according to Bernstein. “We expect that investors will not be happy to no longer receive the clear signals given by the percentage of Azure revenue from AI. We hope that management will supply clear and easy to understand commentary on the strength of AI growth and separately how it is impacting Azure revenue growth / wins.”
Channel Can Benefit From AI, Cloud
Bank of America predicted that average selling price (ASP) growth from Microsoft 365 Copilot attachment could drive Office growth toward 20 percent.
“Channel feedback suggests only early interest in M365 Copilot,” according to the Bank of America report. “We are assuming only $389mn Commercial Office revenue from Copilot in our FY24 base/consensus estimates (assuming 1.5% penetration to eligible installed base by Q4).”
“However, modest penetration upside translates to meaningful incremental ASP growth,” with every 1 percent of penetration meaning 2.5 percent incremental ASP growth, according to Bank of America.
A January report from Wedbush put 60 percent of the Microsoft installed base over the next three years “on this AI functionality for the enterprise/ commercial.”
“While AI use cases will build markedly in FY24 its clear FY25 for Redmond remains the true inflection year of AI growth with pricing, beta customers, and use cases all being rolled out over the next 3-6 months,” according to Wedbush.
Wedbush estimated an additional $25 billion to Microsoft’s top-line by the 2025 fiscal year based on conversations with Microsoft partners on Copilot deployments. “We saw some strong year-end budget flush hit for the December quarter in the last few weeks around cloud stalwarts Microsoft, Amazon, and Google and the overall software sector,” according to the firm.
In a January report from Bank of America, the firm predicted 26.5 percent growth in Azure with 1 percent upside “given system integrator partner feedback suggesting 1) healthy continued migration of new workloads and 2) sustaining adoption of the Microsoft security stack, including offerings such as Sentinel, Purview, and Entra” – Entra being the renamed Azure Active Directory (AD).
Security Market Share
Microsoft’s market share in security looked more mixed in the Morgan Stanley survey compared to the vendor’s advantages in cloud and AI.
Morgan Stanley called Microsoft security rival CrowdStrike the leading market share gainer in endpoint security, beating Microsoft, Palo Alto Networks and SentinelOne, Symantec and IBM. CrowdStrike and Microsoft were expected by CIOs “to gain the largest incremental spend in 2024.”
Microsoft and Okta were the leaders in identity access and management (IAM), with Microsoft widening its lead against Okta in a survey of resellers.
Resellers told Morgan Stanley that Microsoft and Palo Alto Networks were best for expected business growth, with Palo Alto Networks shortening its gap behind Microsoft. The two vendors were followed by CrowdStrike, Dynatrace, Zscaler and Fortinet, according to Morgan Stanley.
Morgan Stanley has put the productivity gains in automation for security organizations at more than $30 billion, with Microsoft, Palo Alto Networks and CrowdStrike the likeliest benefactors.
Based on conversations with resellers, Morgan Stanley reported that customers are “most likely to consolidate observability capabilities on Microsoft in the next three years (30%), well ahead of #2 Splunk at 17% and #3 Datadog, Cisco, and Dynatrace at 13%.”
Morgan Stanley reported that multiple security companies can win in the market, with customers preferring best-of-breed vendors “to manage risk by avoiding over-indexing towards any one particular vendor.”
In the Bernstein report, Microsoft executives were “very excited about the opportunity for Security Copilot and discussed how much security and related data Microsoft has access to which is being used to train the solution.”
Security Copilot is still not yet in market, and the Microsoft Cloud has more than 65 trillion signals coming through it with potential as training data. “We will be watching this product very closely as it could … become very quickly a very compelling offering and disrupt parts of the security space,” according to the Bernstein report.
The executives told Bernstein that security as a whole is a field they are excited by. “Microsoft sees this as a landscape that is only getting more challenging,” according to the report. “You don’t solve security; you manage it, and the problem is constantly evolving, which requires companies to evolve their approach to security.”
PCs, Devices, Chips
For Microsoft’s second fiscal quarter, Morgan Stanley predicted about 7 percent growth year over year in Windows original equipment manufacturer (OEM), in line with Microsoft’s prediction.
The comparable for Windows OEM growth was difficult in the first half of the 2023 calendar year, according to the firm. Part of the reason is Microsoft saw a surge in demand for devices with higher average selling prices in 2021, while the broader PC unit shipments lapped a tougher comparable.
For the second quarter fiscal quarter, Bank of America predicted $16.7 billion in the “more personal computing” segment — which includes Microsoft devices, Windows, Xbox search and news advertising — an 18 percent increase year over year and with a $50 million upside.
Comparing six major AI enablers, Morgan Stanley found that only Google and Amazon checked every box concerning data center hardware, a public cloud offering, in-house silicon, models and applications, end-user devices and partnerships. Microsoft checked every box except in-house silicon. Other AI enablers listed were Nvidia, Meta and Apple.
On the subject of graphics processing units (GPUs), the Bernstein report said that “Microsoft is already leveraging multiple GPUs to support M365 inferencing,” with multiple GPUs from different manufacturers surprising the investment firm.
“Currently Microsoft is utilizing Nvidia GPUs, Microsoft GPUs, and AMD GPUs for their AI services including M365 Copilot,” according to the Bernstein report. “While Microsoft did not explicitly say this, we believe that this is driven both by supply constraints and interest in optimizing performance as different chips may be more applicable to specific workloads / models.”
Bernstein reported that “one of the subjects that comes up each week at the senior leadership team meetings is GPU supply and demand and how best to allocate available chips.”
“This shows, we believe, both the supply tightness and importance of managing / meeting demand to the company,” according to the report.
Microsoft executives told Bernstein that the vendor is moving into creating its own GPUs and central processing units (CPUs) to augment existing vendors and partners.