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Microsoft's Cloud Business Admirably Carries Growth Burden

- By Sangara Narayanan

Microsoft (MSFT) reported third quarter earnings that saw the company continue on its recovery path, posting 7.5% revenue growth. But the shares started edging lower as Microsoft missed Wall Street revenue forecasts.

Microsoft reported earnings per share of 73 cents, which was better than the 70 cents the market was expecting , but revenues of $23.56 billion for the third quarter was $60 million less than what Wall Street was forecasting for the quarter. Since Microsoft was already trading near all-time highs, it is safe to say that there will be a short-term downward price correction over the next few days.


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Image Credits: 1redDrop.com

Microsoft has recovered nicely since 2016, when it saw its earnings decline quarter after quarter. In the last three quarters, Microsoft's revenue growth has steadily improved, from 0.36% during the first quarter to the current 7.59%. Microsoft's sales growth would have been even higher, but More Personal Computing, the segment that counts Windows, Devices, Gaming and Search revenue, declined sharply by 7%, posting $8.836 billion in revenues compared to $9.539 in the year-ago period.

Contrary to my own expectations about a decline in Windows, it was Surface devices that led the downfall with a massive decline of 26%. Though the overall health of the PC market remains stressed, Microsoft was able to increase Windows OEM revenue by 5% and Windows Commercial products revenues by 6%. Gaming revenues increased by 4%. With most of the individual segments in the More Personal Computing growing, it was clearly the sales decline in Surface devices that caused the huge hit on the numbers.

"Surface revenue dropped 26% to $831 million, its lowest figure in more than a year, in part because of more competition from other similar devices and ahead of expected new models expected out later this year. On a call with CNBC, Microsoft said the shortfall was specifically due to "lower than expected Surface Pro unit volume," but noted that one big reason for that product is to spur growth of similar "2-in-1" devices (combo tablet-laptops) across the entire industry."

But other than the Surface shocker, Microsoft did admirably well, with Productivity and Business Processes posting its best numbers ever, growing 22% during this quarter, while Intelligent Cloud grew by 11%. Productivity segment numbers were boosted by strong sales from Office 365 commercial that grew 45%; and Dynamics 365 grew by a whopping 81% compared to last year, and that should grow meaningfully right into the fourth quarter 2017 and beyond on the strength of recent integrations and tools to merge Dynamics 365 with the massive 500-million-strong LinkedIn user base.

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Microsoft Azure, the company's Infrastructure as a Service (IaaS) offering, continued its near-triple-digit growth rate, once again posting 93% revenue growth during the quarter.

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Overall, both cloud segments posted strong sales numbers, which was more than enough to offset the Surface sales drop. The good news is that Microsoft continues to keep increasing the cloud portion of its revenues.

Disclosure: I have no positions in the stock mentioned above and no intention to initiate a position in the next 72 hours.

This article first appeared on GuruFocus.