Google Estimates Microsoft's Cloud Business is Incurring Losses

For a long time, Google has been attempting to gain ground in the cloud infrastructure market, where it is perceived as a distant third in the U.S. compared to Amazon and Microsoft. Investors face a difficulty in that the three companies do not present cloud infrastructure data in a manner that allows for easy comparison.

Google employees have put together an internal estimate, based on a Microsoft document that was made public and other market data, that suggests the company believes it is closer to second place than what analysts have predicted.

Google's report suggests that Microsoft earned less than $29 billion in Azure consumption revenue in the most recent fiscal year, which concluded on June 30. This figure is lower than the expectations of Wall Street analysts. Bank of America had the most optimistic outlook, predicting Azure would bring in $37.5 billion in fiscal 2022. Cowen predicted revenue of $33.9 billion and UBS said $32.3 billion.

According to a document from Google, Azure is projected to end the 2022 fiscal year with an operating loss of almost $3 billion, a decrease from the previous year's loss of more than $5 billion. It is reported that Azure's sales and marketing costs were close to $10 billion, making up 34% of their consumption revenue. Microsoft stated that the sales and marketing costs for the entire company accounted for 11% of their revenue during the same time frame.

An expert in the field disregarded Google's financial report.

Derrick Wood, an analyst at Cowen with a positive outlook on Microsoft stock, expressed his opinion that the loss was not as significant as it seemed. His research indicated that Azure had an operating margin of over 30%, while Google's was estimated to be -10%.The cloud is a highly competitive area in the tech industry, with the most prominent and well-funded American tech companies vying for lucrative contracts from large businesses and government organizations. These entities are increasingly shifting their essential computing and storage needs away from their own data centers.

Google and Microsoft have been putting a lot of money into trying to prevent Amazon Web Services from taking over the market that the e-commerce company created in 2006. However, the two companies have not been completely open about their progress.

Microsoft has seen a year-on-year increase in the usage of its Azure and other cloud services, though the exact amount of growth is not specified. This metric also includes EMS tools, which can be purchased independently.

Alphabet, the parent company of Google, does not provide investors with information regarding the revenue or operating income generated by the Google Cloud Platform (GCP). The only figures that are disclosed are for what is referred to as Google Cloud, which includes subscriptions to Google Workspace collaboration software, as well as GCP, a direct competitor to Microsoft Azure.

Amazon provides investors with a clear view of its cloud operations by reporting both revenue and operating income for AWS. In the third quarter, AWS had an operating margin of 26%, while Google Cloud's operating margin was -10%.

Microsoft has not revealed the gross or operating profit of its Azure division. In 2019, CEO Satya Nadella stated that the utilization of services beyond basic computing and storage could result in "good margins in the long run."

Gartner's data shows that AWS had the largest share of the global cloud infrastructure market in 2021, with 39%. Microsoft was in second place with 21%, followed by Alibaba in China at 9.5%, and Google at 7.1%.

Neither Google nor Microsoft provided a comment for this article.

Google's document references an Insider article that revealed a Microsoft presentation that included Azure Consumption Revenue (ACR) for its U.S. enterprise business in recent years. The document states that the leaked presentation enabled a more precise analysis of the business, and Google's calculations indicate that ACR is the primary source of income for Azure and other cloud services.

Google used the leaked ACR information to make an educated guess about the amount of ACR abroad. They used Microsoft's statement that 51% of total revenue in fiscal 2022 was from customers in the U.S. as a starting point. To get a more accurate number, they added in revenue from other customer segments, such as public sector and regulated industries, by referencing market data from Gartner and other sources.

In order to calculate operating costs, Google used the figure of 65,000 people who are either dedicated to or mainly work on Azure. This number was taken from an Insider report that stated Microsoft's Cloud and Artificial Intelligence organization had more than 60,000 employees.

According to Google, Microsoft's ACR would be approximately 40% the size of Amazon's AWS business and 27% bigger than Google's cloud business.

Google's document states that analysts have included revenue from EMS and Power BI, two SaaS businesses that have high gross margins of over 80%. To get an accurate assessment of Azure's profitability, these allocations must be taken out.

Google determined that Microsoft's Annualized Contracted Revenue (ACR) growth rate decreased from 61% in the 2020 fiscal year to approximately 50% in the 2022 fiscal year. This is still a faster rate of growth than the figure Microsoft reported for all of Azure and other cloud services, which dropped from 56% growth to 45% over the same time frame.

Google estimated that Azure's gross profit, or the amount of money remaining after the cost of goods sold is taken into account, increased from less than 29% in fiscal 2019 to almost 63% in fiscal 2022. Microsoft CFO Amy Hood has stated that hardware and software improvements have enabled the company to expand Azure's gross margin.

At certain levels, cloud computing would not be as profitable as Microsoft's Windows and Office software products. Microsoft's total gross margin for the 2022 fiscal year was approximately 68%.

The three major players in the U.S. market have not revealed the gross margins of their cloud divisions.

Cowen predicts that the Azure and other cloud services sector will make up 27% of Microsoft's income in the 2023 fiscal year. He believes that Microsoft could make the information more precise by providing a more detailed analysis.

Wood suggested that it would be beneficial to have a more detailed disclosure.

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