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Key Morningstar Metrics for Microsoft
What We Thought of Microsoft’s Earnings
Microsoft MSFT continues to deliver with strong third-quarter results, topping both our top- and bottom-line estimates. Given stronger near-term growth and profitability, we are raising our fair value estimate to $435 per share from $420.
Results are impressive from most angles, but we highlight the strength in artificial intelligence, Azure, and gaming. Our key takeaways are the surge in bookings from large Azure deals, as well as robust margin performance despite downward pressure from the Activision acquisition. AI remains the focal point and contributed 700 basis points to Azure’s growth. Management also provided a high-level preview for fiscal 2025 that included double-digit revenue growth and operating margin contraction of about 1 percentage point, consistent with our model. With shares trading up 4% after hours, they remain in 3-star territory.
We see results as reinforcing our long-term thesis centering on the proliferation of hybrid cloud environments and Azure as the firm continues to use its on-premises dominance to allow clients to move to the cloud at their own pace. We center our growth assumptions around Azure, Microsoft 365 E5 migration, and traction with the Power Platform for long-term value creation. AI is also quickly supplementing growth as well, which we see as another secular driver.
For the March quarter, revenue increased 17% year over year to $61.86 billion, compared with the midpoint of guidance of $60.50 billion. We calculate that Activision added about $2.05 billion to revenue. Relative to the year-ago period, productivity and business processes rose 12%, intelligent cloud increased 21%, and more personal computing expanded 17%. Compared with guidance, both MPC and IC came in above the high end, while PBP was just below the high end. Good sales execution and sales mix toward software, away from hardware, buttressed margins.
Microsoft Azure the Key Driver
We see near-term demand as robust, based on strong forward-looking metrics. Commercial bookings surged, growing 31% year over year in constant currency based on large Azure deals. Remaining performance obligation, or RPO, increased 20% year over year against a challenging comparison a year ago to $235 billion. For perspective, there are only a handful of software companies that generate more annual revenue than the $13 billion that Microsoft’s commercial business added sequentially to its books this quarter. Renewals also remain strong, which we think is partly driven by high interest in AI and consistently good execution.
Intelligent cloud performance was critical in an all-around good quarter, as Microsoft cloud revenue increased 23% to $35.1 billion. Azure remains the key driver, and it did not disappoint, coming in at 31% year-over-year growth in constant currency, which was ahead of guidance for the third straight quarter. We also marvel at revenue acceleration on book of business that topped $20 billion in the quarter. After contributing 300 basis points to Azure growth in the September quarter and 600 basis points in the December quarter, AI workloads drove 700 basis points of Azure growth this quarter. Management cited several deals of $1 billion or more and said the number of $100 million deals rose by 80% year over year. We think larger and longer-duration deals are a positive longer-term demand signal and should support growth over the medium term.
Capex Increases, 2025 Forecasts
Management said the company is running into capacity constraints and Azure AI-related revenue could have been even stronger. This had no impact on the company’s internal Copilot solutions. For this reason, Microsoft is investing heavily in capacity expansion, with perhaps $45 billion-$50 billion in capital expenditures this year, and more in fiscal 2025. Given early demand signals and the massive success of similar Azure investments more than a decade ago, we believe these investments will pay off for the company and investors.
In PBP, office and dynamics continue to power performance and drive solid results. Overall segment revenue was up 12% year over year, with Dynamics increasing 17% in constant currency, Dynamics 365 growing 22% in constant currency, and Office commercial products and cloud service rose 12% in constant currency. Overall small and medium businesses performed well, but showed signs of moderation, while Copilot add-ons helped per-seat pricing. Lastly, management disclosed that Teams now has more than 20 million Phone seats and has clearly put Microsoft in the leadership position for a significant long-term market opportunity.
MPC actually drove the most upside relative to the company’s guidance. The year-over-year comparison is distorted by the Activision acquisition. Windows, Activision, and Search and advertising all performed well during the quarter, which supported revenue outperformance. We see early signs of success for the Activision deal, with Diablo 4 added to Game Pass, resulting in strong user adds and engagement.
Like with the bulk of our software coverage, margins have been coming in stronger than anticipated for the last year. Strength is more impressive considering headwinds from the Activision acquisition and the accounting change surrounding useful life and depreciation in certain data center gear. Further, Microsoft is still making heavy AI investments, which we think will start to hit the cost of goods sold line next year and was included in management’s fiscal 2025 preview. GAAP operating margin was 44.6%, compared with 42.3% last year, representing more than 150 basis points of outperformance compared with implied guidance, driven by continued careful cost management, better-than-expected revenue, and favorable product mix. Regarding mix, Xbox and Surface revenue was diminished, while Server, Windows, Azure, and other software solutions were strong.
Guidance was approximately in line overall for the fourth quarter. Management previewed fiscal 2025, which included double-digit revenue growth and a 1-percentage-point decline in operating margin. This was generally in line with our model. Good performance this quarter and several minor tweaks drove our fair value slightly higher. The outlook for the June quarter calls for revenue of $63.5 billion-$64.5 billion and an implied operating margin of approximately 42.3% at the midpoint. Microsoft expects Azure to grow 30%-31% year over year in the fourth quarter, which is stout.
