I think Microsoft (NASDAQ:MSFT) offers the best short- and long-term growth prospects when modeled across different economic environments compared to other mega-caps. Microsoft is in a unique position as companies continue to build their hybrid infrastructure, Microsoft Office and Azure further accelerate market share growth. This effectively shields Microsoft from a crippling slowdown in IT spending on the back of a recession, I believe. There are many reservations about Activision (ATVI) acquisition, which we believe will be successful (with major trade-offs), although the deal will further solidify Microsoft’s leadership position in gaming.
In our view, Microsoft’s dominance in on-premises infrastructure and hybrid cloud workflows gives it a competitive advantage compared to Amazon’s AWS (AMZN) or Alphabet’s Google Cloud (GOOG, GOOGL). Organizations are continually working to upgrade their on-premises infrastructure, which will continue to support continued growth for Azure.
Additionally, Microsoft’s Fortune 500 penetration is staggering with 95% using Azure. This was achieved through hybrid computing, where Microsoft was first to market to provide a mix of on-premises, private and public clouds for its large enterprise customers.
Today, Microsoft is using its lead in the hybrid space by under-pricing other services to win the entire, long-term contract. By owning the entire cloud stack, Microsoft can offer the ultimate differentiator in macro headwinds, “more value for less price,” while competitors don’t own enough of the stack to undercut Microsoft’s price.
Compared to pure public cloud systems, hybrid cloud systems are growing much faster and have a significantly larger addressable market. This is due to the sheer volume of IT spending that older (legacy) companies are making (85% of their spending is on legacy systems) that would be reluctant to move their infrastructure exclusively to the public cloud. This is due to a lack of flexibility to handle billion dollar IT budgets, regulations and/or compliance. This is the prevailing sentiment in the banking and healthcare industries.
According to Gartner’s latest research, global end-user spending on public cloud services is expected to grow to a total of $494.7 billion in 2022. This is in contrast to the total IT spending of $1.9 trillion for 2021. This represents only 21% of the total IT spending attributed to growing cloud infrastructure. It is projected that this will continue to accelerate over the next decade.
We believe any slowdown in Azure growth in 2023 will bounce back in 2024 due to IT budget cuts. With continued accelerating revenue growth rates, edge computing appears to be at the forefront of this next phase, as discussed by management.
Enterprises are using edge computing to improve the response times of their remote devices and gain richer, more timely insights from device data. Edge computing enables real-time computing in places that would not normally be possible and reduces bottlenecks in the networks and data centers that support edge devices.
I think that’s going to drive a lot of those purchases and a lot of that additional spending locally. Of course, sovereignty and the desire to be able to have data or servers nearby are also growing. And these are governments, of course, but there are also industries that are regulated and therefore also follow some of the requirements of those governments, and we see these opportunities as well.
Corey Sanders, Vice President of Cloud at Microsoft
The economy faces a bleak and uncertain future, but Microsoft’s Azure seems well placed to thrive regardless of the economic environment. This is due to the many growth prospects currently in play.
The productivity and business processes segment is mainly characterized by Office 365 and LinkedIn. LinkedIn is empirically sensitive to economic activity and as such may continue to weigh on margins and growth. Reasons for growth within the Office suite of products are the continued growth of teams. This growth is happening in two ways: increases in adoption and price increases to accommodate a security offering.
Microsoft announced its global license price increases in mid-2021. They varied from $1 to $4 per user per month depending on the plan. This represented a 20% increase for the lower tier licenses and a 12.5% increase for the more expensive, high-end tier licenses… the price increase was due to a new security offering… and innovation.
Microsoft 365 price increase
I think the growth rate for the productivity and business process segment could drop to 2-4% in a recession.
IT budgets are directly correlated to GDP growth, our analysis of Microsoft’s sensitivity to US GDP growth, using 2020 as a baseline, shows continued growth in a contraction environment – albeit at a slower pace.
Given that US GDP shrank 3.5% in 2020 while revenue grew ~15%, it shows Microsoft’s resilience to the economic environment. Adjustments need to be made as both recessions are very different, namely with Xbox sales growth in 2020. We believe cloud will continue to drive growth this time around (similar to 2020), but without the tailwinds in other segments . We forecast 8% revenue growth for an identical 3.5% GDP contraction (vs ~15% in 2020).
The following stress analysis further demonstrates this perspective by modeling 4 scenarios: -3.5%, 0%, 1% and 3.5% GDP growth. The catalyst for cloud to continue driving revenue growth in this economic downturn is the continued shift from legacy IT to cloud infrastructure as the need to cut costs materializes. This structural change contrasts with the pandemic, which saw companies “shocked” into the transformation. When it comes to contracts, companies are looking for economies of scale and this is often best offered by large service providers who can offer a full range of services under one roof and usually at a reduced price.
Not many companies can expect to continue on their growth trajectory in a variety of economic environments. This is where Microsoft lands in today’s economic climate and therefore could be the catalyst that will make Microsoft the market leader over the next decade.