Microsoft, Google, Amazon! Can they continue to grow?

With the successive disclosure of Microsoft, Google, and Amazon's earnings reports, investors have observed signs of stabilization in the growth rate of cloud computing in the US stock market. Regarding the confusion in the market about the asynchronous performance of Azure and AWS, CITIC Securities believes that a better explanation can be obtained from the differences in customers and product structures.

Considering the gradual reduction of base pressure in the second half of 2023, the strong resilience of the North American economy, and the gradual contribution of AI, CITIC Securities believes that the sector's revenue growth rate and profit margin are expected to recover in the second half of the year. The integration of AI capabilities is also likely to bring long-term growth momentum to cloud providers in areas such as infrastructure, model optimization, applications, and basic software.

Report Background

Looking back at the second half of 2022, with the rapid deterioration of macroeconomic expectations in the United States, enterprises significantly reduced IT spending and postponed cloud migration plans, leading to a sharp decline in revenue growth for cloud providers.

One year later, with the disclosure of the second-quarter 2023 earnings reports of the three major cloud providers, investors have observed signs of stabilization in the growth rate of cloud providers, and their attitude towards optimizing enterprise cloud spending has changed from negative to wait-and-see.

At the current point in time, CITIC Securities believes that the market is mainly concerned about several issues:

1. Whether the short-term revenue growth rate of cloud providers has bottomed out and whether it can recover in the second half of the year;

2. How to view the future growth prospects of cloud providers and the potential for improving profit margins;

3. How to quantify the contribution of AI to performance and when significant contributions to performance can be seen.

Q2 Earnings Reports of Cloud Giants: Revenue Growth Rate Begins to Stabilize

With the successive disclosure of Microsoft, Google, and Amazon's earnings reports, CITIC Securities has observed signs of stabilization in the growth rate of cloud computing in the US stock market.

Among them, Microsoft Azure's revenue growth rate in CY23 Q2 at a constant exchange rate was 27%, and the growth rate guidance for Q3 was 25%-26%. The decline in growth rates in Q1/Q2/Q3 was 7/4/1~2 percentage points respectively, gradually narrowing;

Amazon AWS's revenue in CY23 Q2 increased by 12% YoY, and the management also observed a similar growth trend in July as in Q2;

Google Cloud's revenue in CY23 Q2 increased by 28% YoY, and the growth rate has remained the same as the previous quarter.

In terms of management's statements, Microsoft stated that the consumption trend in CY23 Q3 will continue from Q2, and the positive impact of AI will be realized quarter by quarter; Amazon stated that customer cost optimization is still ongoing, but they also observed the addition of new workflows, and the trend in July is similar to that of Q2; Google stated that they have not seen any additional factors slowing down demand for cloud computing, and the company will actively explore paths to improve profitability and cash flow.

CITIC Securities believes that the growth rate of cloud computing and the management's statements imply that the current growth rate has stabilized. Considering the gradual reduction of base pressure in the second half of 2023 and the strong resilience of the North American economy, the sector's growth rate is expected to recover in the second half of the year.

Root Cause of Asynchronous Performance of Cloud Giants: Differences in Customers and Product Structures

After the release of Microsoft and Amazon's quarterly reports, investors tend to believe that the growth rate of Amazon AWS has stabilized while the growth rate of Microsoft Azure has not yet bottomed out, which raises doubts about the stabilization of North American cloud spending optimization. According to Citic Securities, this phenomenon can be explained by examining the customer structure and revenue structure of both companies.

1. Customer Structure: AWS enters the market from the perspective of developers, with a significant number of SMBs and digital native enterprises among its customers. These customers received ample financial support and experienced rapid growth in 2020-2021, but have felt the most pressure since 2022.

On the other hand, Azure enters the market from the perspective of enterprise data centers, with most of its customers being medium to large traditional enterprises. These customers are relatively less affected by the macro environment. Therefore, it is not surprising that AWS, which faced greater optimization pressure in the past, is the first to show signs of stabilizing growth after enterprise IT spending stabilizes.

1. Product Structure: Compared to AWS, whose revenue structure is mainly focused on IaaS business, Azure has a significantly higher proportion of revenue from PaaS business. The more fundamental storage and computing services are easier to optimize and control.

At the same time, Azure's revenue includes a significant amount of revenue from security services, which are usually bundled with Office suites and billed on a subscription basis. Considering that the user penetration rate of this business is already high, its growth rate should be lower than that of the company's IaaS+PaaS business. The characteristics of the subscription model itself determine its limited revenue elasticity. Security services may interfere with the overall growth rate of Azure.

Outlook: Significant improvement in revenue growth rate and profit margin expected by 2024

1) Growth potential: According to IDC's research, some enterprises have deferred or slowed down their migration to public clouds due to macroeconomic pressures, with deferral periods ranging from 6 to 12 months. Based on this time frame, the cloud business growth rate, which has significantly slowed down since the second half of last year, is expected to recover in the second half of this year.

In addition, considering that AI computing chips are currently in short supply, with chip supply mainly constrained by TSMC's production capacity, it has greatly affected the pace of AI demand contributing to cloud vendors' revenue. With the release of chip supply capacity, AI-related demand is expected to contribute more to revenue growth each quarter.

2) Profit margin: Citic Securities believes that as revenue recovers and electricity cost remains stable, cloud vendors' gross margin and expense ratio will improve. In addition, although cloud vendors will significantly increase their investment in AI computing power in the future, considering the current shortage of AI computing chips, AI servers that are deployed can quickly generate high-margin revenue, and are not expected to significantly drag down profit margins.