What Wall Street Is Saying About Microsoft Ahead Of Earnings

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Microsoft (MSFT) is scheduled to report results of the second quarter of its fiscal year 2023 after the market close on January 24, with a conference call scheduled for 5:30 pm ET. What to watch for:

CLOUD: In its fiscal first quarter, Microsoft reported revenue in Intelligent Cloud was $20.3B and increased 20% or 26% in constant currency. Server products and cloud services revenue increased 22%, or 28% in constant currency, driven by Azure and other cloud services revenue growth of 35%, or 42% in constant currency.

"This quarter Microsoft Cloud revenue was $25.7 billion, up 24% (up 31% in constant currency) year-over-year. We continue to see healthy demand across our commercial businesses including another quarter of solid bookings as we deliver compelling value for customers," said CFO Amy Hood at the time of the company's last report.

In a recent preview note, Wedbush analyst Daniel Ives said the "whole Street" will be "watching carefully" as Microsoft is one of the best barometers of overall cloud and enterprise spending. The firm believes the stock has already reflected a clear slowdown in cloud and a "disaster" PC market over the last few quarters and its thesis remains that the cloud and underlying Office 365/Windows ecosystem is going to comprise a bigger and bigger piece of the business going forward. This will ultimately spur growth and margins into 2023/2024 despite the macro downturn, according to Wedbush, which added that the shift to cloud is still less than 50% penetrated and represents a massive opportunity for Nadella & Co. going forward despite the dark storm clouds forming for fiscal 2023. Microsoft remains the firm's favorite way to play the cloud theme in 2023 and it maintains an Outperform rating on the shares with a price target of $290.

JOB CUTS: In a regulatory filing on January 18, the company said: "Microsoft Corporation announced to its employees a series of actions it is taking in response to macroeconomic conditions and changing customer priorities. These actions include workforce reductions of approximately 10,000 employees by the end of the third fiscal quarter of 2023, changes to our hardware portfolio, and lease consolidation to create higher density across our workspaces. Collectively these actions will result in a charge of $1.2 billion in the second quarter of our 2023 fiscal year, representing a $0.12 negative impact to diluted earnings per share."

Morgan Stanley analyst Keith Weiss kept an Overweight rating and $307 price target on Microsoft shares after the company announced a 5% workforce reduction in its headcount amid a realignment of investments. The reduction could generate over $2B in annualized savings, reinforcing Microsoft's commitment to margins, Weiss told investors in a research note.

TARGET CUTS AND CONSENSUS EXPECTATIONS: On January 19, Evercore ISI analyst Kirk Materne lowered the firm's price target on Microsoft to $280 from $300 and kept an Outperform rating on the shares. Materne believes that the headcount reduction and cost savings actions taken by the company are an illustration of how Microsoft can dynamically adjust its cost base to preserve EPS and free cash flow even in a more difficult macro backdrop, the analyst tells investors in a research note. He continues to believe that Microsoft will come out of this downturn in a stronger position in terms of being a wallet share gainer and with a more streamlined cost structure.

Meanwhile, Citi analyst Tyler Radke lowered the firm's price target on Microsoft to $280 from $282 and kept a Buy rating on the shares. Challenges may continue for Microsoft in its fiscal Q2 given weakening IT budgets, increasing cloud optimizations and weaker results from Citi's reseller survey and mixed channel checks, Radke tells investors in a research note. Management's recent commentary and the announced layoffs would also suggest a more challenging demand environment, though not worse than most peers, adds the analyst. Radke cut estimates again, despite modest currency tailwinds, factoring in weaker PC market and slower Azure consumption. Despite an expected challenging Q2 setup, the analyst still likes the shares here, noting Microsoft's valuation is at near multi-year lows versus the S&P 500 and that Q2 is likely the trough of revenue and earnings growth.

Current consensus EPS and revenue forecasts for Microsoft's December quarter stand at $2.29 and $52.96B, respectively, according to data provided by Refinitiv. That $2.29 EPS estimate for the fiscal second quarter is down from where it stood 90 days ago at $2.55 per share, according to Refinitiv.

ACTIVISION BLIZZARD: As previously announced, Microsoft plans to acquire Activision Blizzard (ATVI) for $95.00 per share in cash.

On December 8, the Federal Trade Commission announced it is seeking to block Microsoft from acquiring Activision Blizzard, alleging that the deal "would enable Microsoft to suppress competitors to its Xbox gaming consoles and its rapidly growing subscription content and cloud-gaming business." In a complaint, the FTC pointed to Microsoft's "record of acquiring and using valuable gaming content to suppress competition from rival consoles, including its acquisition of ZeniMax, parent company of Bethesda Softworks (a well-known game developer)." Microsoft "decided to make several of Bethesda's titles including Starfield and Redfall Microsoft exclusives despite assurances it had given to European antitrust authorities that it had no incentive to withhold games from rival consoles," the agency said in a press release.

Following the FTC news, Activision Blizzard CEO Bobby Kotick sent letter to all employees, in which he stated in part: "I wanted to provide a brief update on our pending merger with Microsoft. This week the U.S. Federal Trade Commission announced its decision to challenge the deal. This means they will file a lawsuit to block the merger, and arguments will be heard by a judge. This sounds alarming, so I want to reinforce my confidence that this deal will close. The allegation that this deal is anti-competitive doesn't align with the facts, and we believe we'll win this challenge... The competitive landscape is shifting, and, simply put, a combined Microsoft-ABK will be good for players, good for employees, good for competition and good for the industry. Our players want choice, and this gives them exactly that. You can read more about the specifics on those points in this update we recently shared with you. We believe these arguments will win despite a regulatory environment focused on ideology and misconceptions about the tech industry. Thank you for your dedication and creativity."

Brad Smith, Vice Chair and President at Microsoft, tweeted after the FTC announced it is seeking to block the deal: "We have been committed since Day One to addressing competition concerns, including by offering earlier this week proposed concessions to the FTC. While we believe in giving peace a chance, we have complete confidence in our case and welcome the opportunity to present it in court... We continue to believe that our deal to acquire Activision Blizzard will expand competition and create more opportunities for gamers and game developers."

CHATGPT: On January 23, Microsoft announced the third phase of its long-term partnership with OpenAI through a multiyear, multibillion-dollar investment to accelerate AI breakthroughs. The company said in a blog post: "This agreement follows our previous investments in 2019 and 2021. It extends our ongoing collaboration across AI supercomputing and research and enables each of us to independently commercialize the resulting advanced AI technologies. Supercomputing at scale - Microsoft will increase our investments in the development and deployment of specialized supercomputing systems to accelerate OpenAI's groundbreaking independent AI research. We will also continue to build out Azure's leading AI infrastructure to help customers build and deploy their AI applications on a global scale. New AI-powered experiences - Microsoft will deploy OpenAI's models across our consumer and enterprise products and introduce new categories of digital experiences built on OpenAI's technology. This includes Microsoft's Azure OpenAI Service, which empowers developers to build cutting-edge AI applications through direct access to OpenAI models backed by Azure's trusted, enterprise-grade capabilities and AI-optimized infrastructure and tools. Exclusive cloud provider - As OpenAI's exclusive cloud provider, Azure will power all OpenAI workloads across research, products and API services."

In a note about a week prior, Oppenheimer analyst Timothy Horan said he believes OpenAI, augmented by Microsoft money and infrastructure, is "cracking open the door toward Kurt Vonnegut's 1965 reality" that all of humanity's stories fit "eight basic shapes," and "There's no reason [they] can't be fed into computers." At minimum, ChatGPT will be for Cloud what Apple (AAPL) iPhone was for the wireless industry and societal change, said the analyst. Horan expects Microsoft to embed this technology in all of its services, and for it to be a major driver of incremental revenue and ultimately position the company in a more dominant position within every cloud segment with shocking but organic new services. He has an Outperform rating on Microsoft's shares with a price target of $265.

Earlier this month, in a note issued prior to the confirmation of the investment news, DA Davidson analyst Gil Luria initiated coverage of Microsoft with a Buy rating and $270 price target. The stock warrants a premium valuation as the company should be resilient heading into a potential global economic downturn, the analyst told investors. Luria added that in the short term, the unprecedented activity in OpenAI's ChatGPT is translating to incremental volumes for Azure. Longer term, incorporating ChatGPT capabilities into Bing may provide Microsoft with a "once-a-decade opportunity" to unseat Google's (GOOGL) Search dominance, the analyst added.

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