Microsoft financial changes should provide ‘cleaner’ look at Azure: MS

Microsoft’s (NASDAQ:MSFT) announcement last month that it is changing some investor metrics and segment changes should provide a “cleaner” look at its all-important Azure segment, among others, Morgan Stanley said on Monday.

“Azure now appears to be growing faster on a standalone basis ex-EMS and Power BI (FQ1 outlook revised from 28-29% YoY to 33% YoY) and appears to be gaining share at a faster rate compared to peers albeit off a lower base; and most importantly, gives management better visibility over how the loosening of capacity constraints affects Azure’s growth heading into the [fiscal second half],” analyst Keith Weiss wrote in an investor note.

Weiss, who has an Overweight rating and $506 price target on Microsoft, said the restatement now suggests consumption-based revenue from Azure was $56.6B for fiscal 2024, down from a previous estimate of $62.4B.

However, if Microsoft sees the same revenue from Azure in fiscal 2025 that it saw in fiscal 2024, the “incremental uplift and acceleration of Azure may be greater now given the lower base,” Weiss explained.

There may be some concern initially that Azure’s gross margins may be lower after the change, as infrastructure-as-a-service and platform-as-a-service have lower margins than Power Business Intelligence and Enterprise Mobility and Security. However, once investors dig a bit deeper, it should not have much of an impact, Weiss said.

“…[While] the lower margin profile and incremental margin pressure are a negative on its face, this would resonate with the likely margin pressure from an Azure AI infrastructure build out, which we believe is well reflected in our view for FY25 total gross margins to be down ~200bps YoY vs, consensus modeling [less than] 100bps of gross margin compression,” Weiss wrote.

Other changes

Aside from Azure, Microsoft’s changes will turn Microsoft 365 Commercial Cloud into a “primary” key performance indicator, Weiss said, given that it now includes Enterprise Mobility and Security, Power Business Intelligence, Windows Commercial and Office 365 Commercial.

While the change may appear positive, it may obfuscate the growth of Copilot, which is increasingly important to Microsoft’s future, Weiss explained.

“In more detail, Microsoft historically guided to the Office 365 Commercial revenue (we estimated $46.1 billion revenue in FY24), but on a go forward basis will be guiding to the growth of the Microsoft 365 Commercial including the new sub-segments (we estimated $67.6 billion revenue in FY24) which will lower the visibility into the Copilot ramp given it is now part of a business line that is ~47% larger,” Weiss wrote.