Microsoft shares are up around 5.5% the day after the company announced a solid all-around fourth quarter for fiscal year 2016 that beat on both earnings and revenue.
That’s a good sign for Microsoft: The previous quarter, things didn’t go so well, and the share price belly-flopped on news of weak earnings and guidance.
Now, Wall Street is coming back around on Microsoft.
The thing that investors love the most is the growth of Microsoft’s cloud computing business, which grew over 50% overall, with the Microsoft Azure cloud platform showing growth of 108%.
Microsoft CEO Satya Nadella has long positioned Azure, the Office 365 subscription service, and Microsoft’s other cloud products as a way to keep growing even as people buy less traditional software and PCs.
But there’s another, less flashy statistic buried in what Microsoft announced yesterday, and it has analysts especially jazzed: Microsoft is only expecting gross margins to sag a point down from the same period last year, as the cloud computing business sees its own margins start to improve and their investments in infrastructure begin to pay off.
Specifically, Microsoft CFO Amy Hood announced on the earnings call:
“We expect the commercial cloud gross margin percentage and dollars to materially improve next fiscal year. We have invested heavily to build share, expand geographically, ensure world class support and reliability for our commercial customers. Going forward, we expect those investments to provide benefits of scale. We also anticipate our cloud capital expenditure growth curve will slow.”
In a note, Deutsche Bank points out that the bears were projecting a 1.5% to 2% projected dip in gross margin. That’s a solid little beat.
“More so than any other mega-cap tech stock, MSFT seems to be navigating the transition to the cloud and subscription model very well,” Deutsche Bank analysts wrote in a note, which reiterated a “buy” rating. Pacific Crest concurred that the margin news was very good, calling it “the biggest standout from earnings,” but still rates Microsoft as “overweight.”
A big part of the reason for that sag in margins has been because Microsoft has been investing heavily in building out the data centres and server facilities that make services like Azure, Office 365, and Bing run smoothly.
Over the last year, Microsoft spent $7.5 billion on capital expenditures, mainly towards that end. In the last quarter, Microsoft’s gross margins were at 61.2% amid all those investments. Now, it seems that investment is at least starting to pay off.
It’s not all gravy, though. Something all analysts are concerned about is the continued mix between Microsoft’s traditional products and the cloud. Right now, Microsoft is walking a tightrope — even with the slow growth of the cloud, people are buying less traditional software like Office and Windows Server.
If Microsoft can’t grow the cloud businesses faster than its traditional businesses sink, it’s still in trouble. Right now, in the wake of a strong quarter, it looks manageable. But Wall Street will be watching very carefully.