After a jubilant runup to all-time highs, Microsoft (MSFT) shares are taking a pause subsequent to a protracted period of AI optimism for big techs. The tech giant’s elevated levels of AI capital spending that have yet to translate into tangible returns appear to be causing some unease among investors. Exacerbating the concerns, growth in Microsoft’s much-hailed Azure cloud services during the recent fourth quarter was perceived as weaker than expected. The beginning of a Fed rate easing cycle is also motivating investors to look beyond the overheated valuations of mega techs. Microsoft recently announced a 10% increase in its quarterly dividend alongside a mammoth share buyback program of up to $60 billion. Is the Microsoft stock a buy in view of its dividend hike and stock buyback plans? Where is the Microsoft stock headed? Is a $4 trillion valuation in the cards for the MSFT stock?
MSFT Stock’s Recent Performance
After touching a 52-week intra-day high of $468.35 on July 5, the stock receded and closed at a low of $394.44 on August 5 following its fourth-quarter earnings release on July 30. Although MSFT reported better-than-expected earnings and revenues for the fourth quarter, the market chose to focus on the shortfall in its Azure cloud revenues.
MSFT Stock Outlook: What Investors Should Know
Is Microsoft Re-Azuring Investors?
Azure is a key area of focus for analysts, as it competes with Amazon Web Services (AWS) and Google Cloud. Microsoft is going head-to-head with the other two for capturing new business. The investments towards Azure AI growth, drive a significant portion of the capex spend for MSFT. So, it’s good to know that AI services contributed 8 percentage points, accounting for more than a fifth of the growth in “Azure and other cloud services” revenue during the fourth quarter.
In response to an analyst’s query in the fourth-quarter earnings conference call, Microsoft attributed capacity constraints for impacting Azure growth, noting that AI demand remained higher than available capacity. These capacity restrictions alongside softness in non-AI consumption in some European geographies are expected to continue into the first half of fiscal 2025. However, Azure growth is expected to accelerate in the second half of fiscal 2025, as capital investments should increase available AI capacity to serve the growing demand.
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In July, Microsoft noted that its revenue from Azure and other cloud services grew 29% year over year during the fourth quarter. (Typically, Microsoft does not disclose the dollar value of revenue for this category.) The growth was 30% in constant currency (assuming constant exchange rates) in line with Microsoft’s guidance for 30% to 31% growth, but fell short of the 31% growth pegged by analysts. It caught the market off-guard as Azure growth numbers have never missed estimates since 2022.
The lack of visibility into cloud consumption trends also poses a problem. The Azure consumption business (in which businesses only pay for the resources and services consumed), which includes AI, has historically grown faster than the per user business. However, Microsoft typically features the slower-growing per-user pieces in the Azure and other cloud services’ revenue stream, complicating the visibility into the consumption of Azure.
However, in August, Microsoft updated its reporting structure to enhance visibility into its cloud consumption revenue and the benefits of AI for the overall business.
Under the new reporting framework, the slower growing per-user revenue streams such as the Power BI data analytics tool and the Enterprise Mobility and Security (EMS) product suite will be excluded from the closely monitored Azure and other cloud services metric. With the relocation of these two components, the new Azure number is expected to now align more closely to the consumption business. However, Microsoft will be adding revenue from its search and news advertising category into Azure and other cloud services.
So, the updated Azure and other cloud services revenue growth metric will include revenue from Azure and other cloud services, including cloud and AI-consumption based services, GitHub cloud services, Nuance Healthcare cloud services, virtual desktop offerings and other cloud services.
Subsequent to the reclassification, Microsoft restated its investor metrics, including Azure and other cloud services revenue growth and updated its first-quarter guidance. Based on the restatement, revenue from Azure and other cloud services for the fourth quarter grew 34% to 35% in constant currency (vs. 29% to 30% growth in constant currency reported in July). For the first quarter, revenue growth for the new Azure and other cloud services is expected to be 33% in constant currency (vs. prior projections for growth of 28% to 29% in constant currency in July).
Based on the takeaways from the July earnings call, there appears to be no slowdown in demand for Azure consumption. The quote from Microsoft’s CFO Amy Hood, “Azure consumption business continues to grow faster than total Azure.” has a nice reassuring ring to it. With the reorganization in reporting structure, the upcoming first quarter earnings print will likely offer more helpful context on how Azure is shaping up for the second quarter and future periods.
Microsoft’s Copilot: A Future Driver Of Recurring Revenues
Microsoft’s intelligent digital assistants called Copilot streamline workflows. Copilot can help draft emails and reports, summarize documents, provide data insights, create presentations, generate software code and automate repetitive tasks. About 60% of Fortune 500 companies have adopted Copilots.
Copilot is used in GitHub (which is a code-sharing platform) for providing AI assistance in software coding. More than 77,000 organizations have adopted GitHub Copilot, and the number is up 180% year over year. The use of Copilot has pushed GitHub’s annual revenue run rate to $2 billion and accounted for 40% of GitHub’s revenue growth in fiscal 2024.
Copilot for Microsoft 365 is gaining solid traction; customers grew more than 60% quarter-over-quarter, while the number of people who used Copilot daily at work doubled. The number of customers with more than 10,000 seats more than doubled quarter over quarter, including Capital Group, Disney, Dow, Kyndryl, Novartis and EY, which alone is expected to deploy Copilot to 150,000 of its employees.
Copilot is still in the nascent stages of growth, but already showing great promise as a future driver of recurring revenue growth for MSFT. With the rollout of additional features and functionality, Copilot is expected to deliver even greater value. The Copilot add-on for Microsoft 365 plan costs $30 per user per month, while a basic business subscription for Microsoft 365 costs $6 per user per month, a standard business subscription costs $12.50 and a premium business subscription costs $22.50.
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Addressing The Billion-Dollar Capex Question
During its fourth-quarter earnings call, Microsoft addressed the elephant in the room–the raging industry debate about the monetization of its significant investments in generative AI. Capital expenditures, including finance leases, totaled $55.7 billion for fiscal 2024 (including $11.2 billion in first-quarter 2024, $11.5 billion in second-quarter 2024, $14 billion in third-quarter 2024 and $19 billion in fourth-quarter-2024) up 75% year over year. A bulk of the capex spend is towards cloud and AI-related investments.
Microsoft said that nearly 50% of its capex went towards infrastructure needs, like the land and data center buildout, while the rest was decided by “demand signals.” CPUs or GPus will be bought only based on these demand signals. Azure AI growth, and recurring customers for Microsoft 365 Copilot are some of the demand signals that decide the trajectory of more than 50% of Microsoft’s capital spending toward cloud and AI-related investments.
While responding to an analyst’s question, Microsoft said it could see consistent revenue growth even without this sort of elevated capital expense because of the variable nature of the capex.
In what could be viewed as an elaboration on the demand signals, Microsoft said it witnessed record commitments to its Microsoft Cloud platform in the fourth quarter and commercial bookings were significantly ahead of expectations rising 17% (and 19% in constant currency) year over year, thanks to growth in the number of $10 million-plus and $100 million-plus contracts for both Azure and Microsoft 365. Microsoft has more than 60,000 Azure AI customers, up nearly 60% year over year with the average spend per customer continuing to grow.
Microsoft said that the expansion of its data center footprint targeting investments across four continents aimed to create long-term assets globally to drive growth for the next decade and beyond. Fiscal 2025 capex is expected to be higher vs. fiscal 2024, and tied to demand signals and adoption of its AI-based services. MSFT plans to be more disciplined to keep its opex growth in the single digit for fiscal 2025 to somewhat compensate for the higher capex.
Besides, cash flow from operations surpassed $100 billion for the first time, reaching $119 billion for fiscal 2024, resulting in an attractive free cash flow (FCF) generation of approximately $74 billion, even after the escalated spending. Strong FCF generation characteristics render solid support for Microsoft’s capital spending plans. MSFT appears to have adequately addressed the concerns regarding its capex boost for fiscal 2025. It is now up to investors to take a deep, long look and decide if they are comfortable with the answers.
Other Microsoft Growth Catalysts
Gaming
Xbox content and services revenue increased 61% during the fourth quarter, of which 58 points were attributed to Activision. The acquisition of Activision has given Microsoft a strong content pipeline and a foothold in mobile gaming, a turf where it virtually had no presence before. In gaming, Microsoft now has more than 500 million monthly active users, across devices and platforms.
Microsoft’s official cloud gaming service, Xbox Cloud Gaming, allows a user to play native console games in the cloud and stream it to a phone, PC, or console. The game catalog for Xbox Cloud Gaming has more than 200 titles including a number of EA Play games that make it quite appealing for users. Xbox Cloud Gaming is only available for Xbox Game Pass Ultimate subscribers, a service that costs $19.99 a month. For the first quarter, Xbox content and services revenue is expected to grow in the low to mid-50s percentage. Gaming could likely turn out to be a good revenue avenue, amid the projected growth in the global cloud gaming market from an estimated $5.8 billion in 2023 to $9.7 billion in 2024, thanks to the rise in mobile cloud gaming, according to Fortune Business Insights.
Growing Partnerships
Microsoft has made partnerships the cornerstone of its growth strategy. To understand the economic value partners realize through their collaboration with Microsoft and its technology—particularly with AI, IDC conducted a global study (commissioned by Microsoft). A key finding of this web-based global survey of 638 Microsoft partners was the “partner multiplier” metric. For every $1 of Microsoft revenue, Microsoft partners who provide services generate $8.45 and partners who develop software generate $10.93. This compelling number could spur further partner-led growth for MSFT.
Perceived Risks
In its fourth-quarter earnings call, Microsoft noted that it “continues to prioritize security above all else.” It has more than 1.2 million security customers. “Defender for Cloud”—MSFT’s cloud security solutions for protecting customer workloads across multi-cloud and hybrid environments surpassed $1 billion in revenue for the past year (as of July 31, 2024).
It is interesting that Nadella should reinforce MSFT’s commitment to prioritize security above all else. On July 18, cybersecurity firm CrowdStrike released a flawed software update, crashing millions of Windows devices. Microsoft pegged this estimate to 8.5 million Windows devices representing around 1% of all Windows machines. However, many of these customers were providers of critical services, like airlines and Banks. Although the outage was caused by the CrowdStrike update, Microsoft may likely face some pushback about the perceived chinks in its operating system.
Of course, other risks include Microsoft not meeting its AI objectives and the subsequent repercussions that could stem from it.
Microsoft Vs. Amazon Vs. Google: The three-way battle
Cloud revenues and operating income for the latest June quarter:
- Microsoft: Microsoft does not break out Azure dollar figures separately. Microsoft Azure revenue is included in its Intelligent Cloud group, which reported $28.5 billion in revenue, up 19% year over year. Operating income rose to $12.9 billion, from $10.5 billion in the year-ago period.
- Amazon reported AWS sales of $26.3 billion, up 19% year over year and operating income of $9.3 billion vs. year-ago $5.4 billion.
- Google Cloud reported sales of $10.3 billion up 29% year over year. Operating income rose to $1.2 billion from year-ago $395 million.
Cloud Market share
New data from Synergy Research Group, which tracks IT and cloud data, shows that second-quarter enterprise spending on cloud infrastructure services totaled $79 billion globally, up 22% year over year. Amazon remained the market leader during the June quarter with a 32% market share, followed by Microsoft at 23% and Google at 12%.
Microsoft’s Generative AI And AI Chips
Microsoft’s lead in generative AI and large language models (LLMs) is narrowing. Microsoft had a head-start advantage in the space through its investment in OpenAI, the creator of ChatGPT. However, Amazon’s investment in Anthropic (the creator of Claude LLMs) and Google’s introduction of its Gemini model are leveling the playing field. Although ChatGPT remains the most popular chat-bot currently, experts opine that the offerings from Anthropic and Google have demonstrated superior performance vs. ChatGPT on various benchmarks.
While Amazon and Google are playing catchup with ChatGPT, MSFT is adding its own in-house data center-bound AI chips, the Azure Maia 100 AI Accelerator for training and running AI models, and the Azure Cobalt 100 CPU, which is optimized for general purpose workloads. As of now, MSFT accounts for nearly 20% of Nvidia’s revenues, while Google and Amazon represent about 5% each. With its own AI chips, MSFT has the potential to close the much-touted cost advantage with AMZN and GOOG.
Microsoft’s Huge Stock Buyback Program
In mid-September, MSFT announced a new $60 billion stock buyback program, aligning with its largest repurchase authorization to date. The new buyback authorization, which represents nearly 2% of MSFT’s market cap of $3.1 trillion, has no expiration date and replaces a $60 billion buyback program announced in 2021.
Shareholder return initiatives are not new for Microsoft, which returned more than $34 billion to shareholders via dividends and buybacks in fiscal 2024. The company has repurchased shares consistently over the last two decades. However, the new buyback authorization does signal that the tech giant remains committed to robust free cash flow generation, despite its elevated AI-driven investments.
Atop the battle for AI dominance, the top tech majors are also actively competing on buyback and dividend programs, which bodes well for shareholders. In May, Apple announced the biggest-ever $110 billion stock buyback authorization, following Google parent Alphabet’s $70 billion buyback authorization announcement in April. Microsoft ranks third so far this year in terms of buyback size. In February, Meta authorized an additional $50 billion in share repurchases, which represented 5% of its $1 trillion market cap at the time. Meta’s market cap has since grown by 50% to $1.5 trillion.
MSFT Stock’s Dividend Hike
Microsoft increased its quarterly dividend payout by 10% or 8 cents to $0.83 per share from the present $0.75 per share and made the announcement in mid-September along with the buyback plans. The dividend is payable to shareholders on December 12. MSFT stock goes ex-dividend– the cutoff date for new buyers of the stock to be eligible for the upcoming dividend–on November 21. At current stock prices, the new dividend has a forward yield of nearly 0.8%.
Here’s a fun fact. Every year, the new quarterly dividend increase tops the year-ago dividend increase by a penny–a pattern that can be observed since November 2021. For example, the upcoming new dividend is $0.83 per share, a 8-cent increase from $0.75 per share in 2023, which is a 7-cent increase from $0.68 in 2022, and this represents a 6-cent increase from $0.62 in 2021.
Microsoft has paid and grown its dividend for two decades now. This compares very favorably with the sector’s ten consecutive years of dividend payment and one year of dividend growth. Considering that Microsoft has consistently paid and increased dividends, there isn’t much in the way of surprises that would significantly impact MSFT stock behavior—unless Microsoft were to halt or cut its dividend payments. Such a move could serve as a notable negative catalyst, though the probability of that occurring is extremely low. Currently, Microsoft distributes more than 25% of its annual earnings as dividends, which seems safe and sustainable for now. Earnings reports, company developments and competitive dynamics have a stronger sway on MSFT’s stock price.
Amid the pressure to show payoffs on their huge AI capital spending, other mega techs are turning more shareholder friendly. In February, Meta joined the throngs of Apple and Microsoft, by initiating its first-ever dividend of 50 cents per share, which would be paid on a quarterly basis. After the dividend announcement on February 1, META stock closed 20% higher on February 2. Google parent Alphabet initiated a cash dividend of 20 cents per share in April and the stock gained 10% the next day. Amazon is the only major tech that does not offer a dividend yet.
What Analysts Are Expecting For MSFT Stock
Wall Street analysts are overwhelmingly bullish on the MSFT stock with an average price target of $496, which represents roughly an 18% upside from current stock price levels of around $420. MSFT stock has no Sell ratings and a few Hold ratings.
Goldman Sachs (GS) maintains a Buy rating but reduced the price target on Microsoft to $500 from $515. GS expects 14% revenue growth for the first quarter, inline with the consensus, and sees EPS of $3.14, slightly above the consensus.
Oppenheimer downgrades Microsoft to “Perform” From “Outperform,” citing higher-than-expected losses from Microsoft’s OpenAI investment and slower enterprise adoption of AI technology.
Analysts at D.A. Davidson downgraded the stock to “Neutral” from “Buy,” keeping the price target unchanged at $475, citing concerns over the narrowing AI lead of Microsoft vs. rivals Google and Amazon, and MSFT’s heavy reliance on Nvidia for AI infrastructure.
Jefferies is keeping its Buy rating, and price target unchanged at $550, citing the strong performance of Azure, and the promising trajectory of the M365 Copilot initiative.
Is MSFT Stock Heading To A $4 Trillion Market Value?
MSFT is 10% off its 52-week intraday high reached on July 5. After more than doubling in value over the past two years, a 10% correction in the MSFT stock is not exactly devastating. It could also be an opportunity to buy into a quality, futuristic business with the stock headed for new heights.
In the near-term, there’s a very high likelihood of the Microsoft stock revisiting its highs, given an upcoming key catalyst, Microsoft’s first-quarter earnings report scheduled for release on October 30.
In the longer run, AI is here to stay and is not going anywhere in a hurry. By building an evolving AI ecosystem around its products, MSFT is positioning itself as a major force within AI and cloud services. The market is in the “show me the money” mode. However, investors should remember that data centers cannot be built in a day and scaling up is a herculean task. Microsoft is definitely making progress and AI investments are already generating additional business for Microsoft, as can be seen by the strong signups for Azure AI and Microsoft 365 Copilot.
Analysts expect $140 billion in incremental revenue from AI services for MSFT by 2027. Adding this to the fiscal 2024 revenue of $245 billion, Microsoft has the potential to reach a $4 trillion valuation by 2027 based on its five-year average price-to-sales ratio of 10.6x, representing 30% upside from current levels. Not to forget the long-term dividends and share buybacks that could further unlock value for investors.
Microsoft stock is the top holding of the Bill & Melinda Gates Foundation Trust. The Trust owns roughly $14.7 billion worth of Microsoft stock, representing about 30% of its $48 billion portfolio.
Bottom Line
Microsoft has been growing dividends and implementing buybacks over the last two decades. So, the recent buyback/dividend announcement is not expected to have much sway on the stock price. If the stock rallies, it could be attributed to the upcoming first-quarter earnings report slated for release on October 30. It appears that Microsoft has adequately addressed the concerns related to its capital spending in its fourth-quarter earnings call, expounding on the growing demand signals for Azure and Microsoft 365 Copilots and the variable, demand-driven nature of capex. Strong FCF generation characteristics render support to its capital spending plans. The revamp to its reporting structure will likely enhance visibility into its cloud consumption revenue and the benefits of AI on the overall business and ease any investor apprehensions. With growth in Xbox Content and Services revenue, gaming will likely shape up to a decent revenue stream as the global cloud gaming market gathers pace. Microsoft has the potential to reach a $4 trillion valuation by 2027, if all goes as planned.
Please note that I am not a registered investment advisor and readers should do their own due diligence before investing in this or any other stock. I am not responsible for the investment decisions made by individuals after reading this article. Readers are asked not to rely on the opinions and analysis expressed in the article and encouraged to do their own research before investing.
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