Microsoft released its second-quarter earnings report last Tuesday, and the results weren’t great. Microsoft MSFT missed analysts’ expectations for sales and narrowly beat earnings. But what’s worse is that following the call, the MSFT stock was downgraded and lowered its forecast.
There was one silver lining on the earnings call, however, which was Microsoft’s cloud segment. Although growth was noted to be slowing, cloud services still saw 18% year-on-year growth, and Azure in particular grew 31% year-on-year.
While growth rates are down from +60% per year in recent years, cloud services remain an extremely valuable and rapidly growing segment of the market, and big tech knows it. The continued growth potential of cloud computing has intensified competition between Amazon AMZNAlphabet GOOGL, and Microsoft. All three are engaged in a long-term arms race to dominate the crucial cloud market.
Cloud
Cloud computing and cloud services is one of the fastest growing industries in the market today. The global cloud computing market is valued at $369 billion and is expected to grow 15% annually to reach $1.6 trillion by 2030, according to Allied Market Research.
Cloud computing is a remote computing option for individuals and institutions. It allows users to minimize the initial cost of IT infrastructure and provides flexible capacity for storage, computing power, communication and several other technology-related resources.
Accelerated in part by working from home, as well as the expanded computing capabilities made possible by the cloud, businesses are rapidly embracing the computing paradigm.
There are three main types of cloud computing services:
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Infrastructure as a Service (IaaS) – IaaS is where the provider delivers computing services such as computing power, storage, and servers. This allows users to scale hardware requirements up or down without actually owning the hardware.
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Platform as a Service (PaaS) – PaaS is an option for users to use a cloud environment to develop, manage, and host applications. This comes with testing and support tools, and the platform supports security, operating system, and backups.
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Software as a Service (SaaS) – SaaS is a service where software is accessed remotely through the cloud, instead of having to be installed locally.
Competition
The competition for cloud dominance is fierce. While we’ve already received an update on MSFT’s most recent cloud service earnings, Amazon and Alphabet’s earnings reports this week will provide a fuller picture of how competitors stack up.
According to Synergy Research, in the third quarter, the cloud services industry made a total of $57 billion, an increase of 24% or $11 billion over the previous year. While impressive, this shows a deceleration in revenue, with Q2 year-over-year growth at 29%. While macroeconomic factors may play a role in the deceleration, this is also what happens as industries mature. As the market saturates more with demand, growth inherently slows.
The current leader, Amazon with AWS, has been slowly losing market share over the past two years. Amazon’s market share in 2020 was estimated at 41% and it’s now down to 34%. AWS third-quarter revenue was $20.5 billion, below analysts’ estimates of $21.1 billion.
Image source: Synergy Research
That means Microsoft isn’t alone in seeing slower cloud growth. In its third quarter earnings report, AWS posted 27% year-on-year growth, which was below analysts’ expectations, and down from the prior quarter which saw 29% year-on-year growth. .
There was an outstanding performance in the third quarter. Google’s cloud service was the only one to see year-over-year growth in the third quarter. Different from the other two, GOOGL is currently running its cloud division at a loss, while MSFT and AMZN are running their cloud business profitably with wide margins. Reinvestment in sales by GOOGL can make the difference now.
Alphabet is also the least dominant in the space, so there may be an urge to catch up with competitors.
Earnings from GOOGL and AMZN this Thursday, February 2 will provide much more clarity on where the competition is headed.
Winner?
If I had to pick one that I think will outperform, I would buy GOOGL stock. As the smallest percentage in the industry and the fastest growing of the three, I think agility will be an advantage. Also, since they are not yet focused on running the business for profit, as their other lines of business generate huge amounts of cash, it allows them to reinvest more aggressively in growth.
Alphabet is also relatively cheaper than Amazon and Microsoft. With a one-year forward P/E of 19.5x, it is below Microsoft’s 25x multiple, below its five-year median of 24x and close to the 16x low.
In terms of multiples, AMZN isn’t even in the conversation as it is still trading at a forward P/E of 57x. Also, since Amazon is now so dependent on free cash flow from AWS, they may be more focused on maintaining that, rather than growing market share, which is already shrinking.
Image source: Zacks Investment Research
Economic sensitivity
Although industry growth is slowing, it appears cloud services remain resilient in a slowing economy. This is extremely important for large tech companies as the cloud continues to become a bigger addition to their bottom line. Additionally, in the big three, they are all seeing an outright deceleration or reduction in their core business, further emphasizing the importance of the cloud.
Conclusion
Cloud infrastructure is an increasingly important contributor to big tech revenue, economic growth, and business productivity. He’s already made a massive impact, and although growth is slowing, he’s likely to continue to be a leader for many years to come.
The big three of MSFT, GOOGL and AMZN are battling to see who will be the leader. With the incredible competition between them, users will see additional competitive pricing, new features, and an expanded use case for the technology.
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