Microsoft Set to Face Tallest Bar in Tech Industry

Microsoft (MSFT) is a leading technology company with a market capitalization of over $1 trillion.

It is best known for its Windows operating system and Office suite of productivity software. Microsoft also has a strong presence in the cloud computing, gaming, and hardware markets.

It is possible that a company might be planning to do more with less. However, investors expect the company to do much more in order to be successful.

The software company will release its second quarter earnings report on Tuesday, amid concerns about a declining PC market, slowing corporate software sales, and unclear demand for cloud computing services.

Microsoft's forecast from three months ago caused investors to worry, and the company's recent decision to join other tech giants in a wave of layoffs seems to confirm those fears. "We will have to do more with less," Chief Executive Satya Nadella told the World Economic Forum in Davos, Switzerland, last week. The company has now announced plans to cut 10,000 jobs from its payroll.

This would suggest that the upcoming report will not be very positive. Analysts believe that Microsoft's revenue for the December quarter only grew by 2.7% compared to the previous year, which is the company's lowest growth rate in nearly six years. They also expect Azure's growth to hit a record low of 30.5% year over year, which is a decrease of nearly 5 percentage points from the previous quarter.

Revenue from personal computing is expected to drop 14% this year, compared to 15% growth last year. This is a big change from the previous year, when the company was still benefiting from increased PC sales due to the pandemic.

Microsoft's forecast for the March quarter and its outlook for the rest of the year will be crucial in determining the company's future. Wall Street expects growth to pick back up in the second half of the calendar year, and Microsoft is expected to maintain annual operating margins above 40%. This would make Microsoft the most successful big tech company in terms of profitability, ahead of Apple, Amazon.com, Google, and Facebook.

Wall Street is projecting that Microsoft's operating margin will be about 41% in calendar year 2023. This is nearly 5 percentage points higher than what the company averaged over the five-year period from 2017 to 2021. This is a much larger margin improvement than what the other four big tech companies are expected to show over the same period.

Is the company able to achieve that goal? It's possible. Corporate tech officers are reducing their spending plans; Gartner projected that worldwide IT spending will grow by 2.4% this year - which is less than half of the growth rate that the market research firm predicted three months ago.

Microsoft is still in a strong position due to its large public cloud service and ownership of many popular business software tools and applications. A recent survey by Morgan Stanley found that 38% of chief information officers rank Microsoft’s Azure as their preferred cloud provider, compared with 31% for Amazon’s larger AWS service.

Microsoft still has a lot of exposure to the PC market, which is in free fall. According to IDC, PC unit sales slid 28% year over year in the fourth quarter—the biggest drop that the market research firm has seen in years. IDC doesn't expect the PC market to recover until 2024.

On January 17, analyst John DiFucci of Guggenheim downgraded Microsoft to a sell rating. He cited the PC slowdown and Microsoft’s strong exposure to small businesses as reasons for his decision. DiFucci believes that small businesses typically fare worse than enterprises in a macro slowdown.

Even if Microsoft were to lay off 10,000 workers, it might not have much of an impact. That's because Microsoft added 40,000 employees in the fiscal year that ended in June 2022, which included the company's acquisition of Nuance Communications. In his email to employees announcing the layoffs, Mr. Nadella made clear that "we will continue to invest in strategic areas for our future," which includes the adoption of potentially expensive AI technology like ChatGPT across the company's products.

Microsoft's successful transition to a cloud-based company has won the trust of investors. Its ability to maintain high margins in the face of a possible recession will test that trust.