As supply chain constraints, inflationary pressure and regulatory scrutiny darken the outlook for some of Microsoft Corp.'s key businesses, the forecast for the company's thriving cloud business remains bright.
The company last month lowered guidance for its fiscal fourth quarter ended June 30, mostly due to foreign exchange headwinds from the persistently strong U.S. dollar. Ongoing supply chain shortages and inflation are also weighing on Microsoft's hardware division.
The Azure cloud-computing business is poised to remain Microsoft's biggest growth machine due to rising customer demand. Analysts expect the cloud business's momentum to offset short-term currency fluctuations as well as any inflationary pressures.
"Clearly, a softer macro will negatively impact Microsoft as well as the overall tech industry," said Wedbush analyst Dan Ives. "However, we stress the Azure/cloud migration looks robust to us based on checks and should be able to stay above 40% growth threshold in 2023."
Cloud dominance
For its June quarter, Microsoft is expected to post consolidated revenue of $52.37 billion, up 13.5% from the year-ago quarter, according to S&P Capital IQ estimates. That would be the smallest year-over-year growth rate in more than a year.
Microsoft's Intelligent Cloud segment, which includes Azure, is expected to experience a similar slowdown, adding about 22% growth, compared to 26% in the March quarter. However, the growth rate for Azure alone is expected to remain at 46% for the third consecutive quarter.
Wedbush analysts expect Azure to ramp up even more in the future.
"We believe 85% to 90% of major cloud projects are already green-lighted for Microsoft into the next year, which give a very high level of visibility and confidence around cloud commercial growth, despite the dark macro storm clouds on the horizon," Ives said.
Nevertheless, Microsoft's cloud business is not completely immune to the weakening economy, as indicated by recent reductions in hiring within Azure and its security unit. The hiring slowdown will continue for the foreseeable future, Microsoft confirmed. The company declined to offer any additional information.
"With Microsoft slowing hiring across the board along with other tech stalwarts, we believe management is keenly aware of a very rocky macro that could impact demand around the edges in 2023 and is making the prudent proactive expense moves, which we loudly applaud," Ives said.
Shares in Microsoft were down 22.6% year to date as of market close July 22, in line with declines seen by the tech-heavy Nasdaq.
Hardware sales slump
Supply chain issues continue to take a toll on sales of Microsoft's hardware, including Xbox game consoles and Surface PCs. The company forecasts that its More Personal Computing segment, which includes hardware sales, will report year-over-year growth of about 4% in the June quarter, down from 11% in the March period.
The guidance factored in quarter-to-date supply chain impacts from shutdowns in China following a resurgence of COVID-19 in the region as well as the war in Ukraine.
Microsoft is working with its manufacturing and retail partners to expedite production and shipping to keep up with demand for its devices, a company spokesperson told S&P Global Market Intelligence.
However, demand may soften due to inflationary pressures, adding risk to Microsoft's hardware business.
"The reality is the dollar has gotten much stronger against foreign currencies, which makes it more expensive for international customers to buy products," said Scott Kessler, global sector lead for TMT at research firm Third Bridge. "We're likely going to see a scenario where there is more inventory available because of easing supply chain concerns but lesser demand due to inflation."
Activision deal
Another headwind for Microsoft is growing regulatory scrutiny of its pending $69 billion acquisition of Activision Blizzard Inc. The European Commission and the U.K.'s Competition and Markets Authority in July launched investigations into whether the deal may harm competitors by shutting them out from the game-maker's popular franchises, such as Call of Duty.
The U.S. Federal Trade Commission and the Australian competition regulator are also looking into the deal.
"What looked like a surefire transaction initially is now increasingly turning into a significant regulatory headache for Microsoft, which has now drawn eyes of every major regulator around the globe," said John Freeman, vice president of equity research at CFRA.
"There are many more potential areas Microsoft could expand to if it wants to expand its gaming offerings that would cost much less than Activision and draw less heat from regulators," Freeman added.
For now, Microsoft seems likely to agree to regulatory conditions to get the deal approved, even if it means allowing competitors such as Sony Group Corp. and Nintendo Co. Ltd. to continue accessing Activision's games in the coming years, said Third Bridge's Kessler.
"The monetization of Activision's valuable IP is really at the heart of this transaction's rationale," Kessler said. "More important than attracting consumers to Microsoft platforms such as Xbox and Game Pass is the value this IP will add to future efforts, such as building out the Metaverse."