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Microsoft versus Amazon: What Acquisitions Could Move the Needle?

Posted on Friday, Feb 1st 2019

Earlier this week, Microsoft (Nasdaq: MSFT) reported a mixed quarterly result. While revenues missed the market’s forecast, it managed to deliver a slight earnings beat. Its cloud business continued to deliver growth, but Microsoft Azure’s performance failed to impress.

Microsoft’s Financials

Microsoft’s Q2 revenues grew 12% over the year to $32.47 billion, marginally shy of the market’s forecast of $32.51 billion. Microsoft attributed the miss in revenues to the PC market as revenue from copies of Windows software pre-installed on PCs fell 5% over the year. EPS of $1.10 was marginally ahead of the Street’s expectations of $1.09.

By segment, revenue in Productivity and Business Processes grew 13% over the year to $10.1 billion driven by an 11% growth in Office Commercial products and cloud services. Office Consumer products and cloud services revenue increased 1% with Office 365 Consumer subscribers growing to 33.3 million. LinkedIn revenue increased 29% with LinkedIn sessions growing 30%.

Revenue in the Intelligent Cloud segment grew 20% to $9.4 billion with Server products and cloud services revenue growing 24% and Azure delivering a 76% growth.

Revenue in More Personal Computing grew 7% to $13 with Windows OEM revenue declining 5% and Windows Commercial products and cloud services revenue increased 13%. Gaming revenue increased 8% with Xbox software and services revenue growing 31%.

For the current quarter, Microsoft expects revenues of $29.4-$30.1 billion for the quarter, compared with the market’s forecast of $29.9 billion. The currency headwinds are expected to hurt Microsoft’s intelligent cloud business segment revenues by 2 percentage points.

Microsoft’s Azure Growth

Microsoft continued to drive growth within the cloud segment. But the market is used to seeing stronger numbers from Microsoft. For the recently ended quarter, Azure recorded a 76% growth – which was flat to the previous quarter and significantly lower than the 98% growth reported a year ago. Analysts are worried that Azure may be losing traction. But during the quarter, Microsoft has won some big names for its commercial cloud. Within the retail segment, it has seen strong adoption with names like Walgreens, Walmart, and Gap becoming its cloud clients. Part of the reason for the retail growth is that retailers want to own their own data and they want a partner, not a potential competitor. Amazon’s presence in the e-tail market hurts its prospects within the segment.

Despite the growing clientele, Microsoft is still quite a distance behind Amazon’s leadership. According to a Synergy Research Group report, AWS remains the leader of the public cloud infrastructure space with 34% market share. Microsoft is a distant second with 14% share, followed by IBM Cloud at 7%, and Google Cloud at 6%. While Azure may be gaining ground, analysts don’t expect it to surpass Amazon’s leadership within the next five years.

Microsoft’s Acquisitions

Meanwhile, Microsoft continues to invest in technology through acquisitions. It has been purchasing both smaller startups as well as bigger players. Earlier this year, it announced the acquisition of San Francisco-based Citus Data for an undisclosed sum. Founded in 2010, Citus Data’s solutions are based on PostgreSQL and help unlock the power of data to scale complex multi-tenant SaaS applications and accelerate the time to insight with real-time analytics over billions of rows. The acquisition of Citus Data will help Microsoft build on Azure’s open source commitment and help it deliver higher scalability and performance that are needed by customers as their workloads grow. Prior to the acquisition, Citus had raised $13.2 million in venture and seed funding at undisclosed valuations.

Some of the other smaller acquisitions made by Microsoft in the recent past include Suwanee, Georgia-based FSLogix and Texas-based XOXCO. FSLogix is an app-provisioning platform that reduces the resources required to support virtualization. Its Dynamic Application Visibility solution enables policy-based control for application visibility. FSLogix had raised $10.3 million prior to being acquired. Microsoft plans to leverage FSLogix’s capabilities to improve the Office 365 virtualization experience.

Microsoft acquired XOXCO to help advance conversational AI. XOXCO is a software product design and development studio known for its conversational AI and bot development capabilities. It was responsible for the creation of Howdy, the first commercially available bot for Slack that helps schedule meetings, and Botkit, which provides the development tools used developers on GitHub. Microsoft is integrating the acquired capabilities in its Bot Framework, that is already available as a service in Azure and on GitHub. It plans to leverage the acquisition to realize its approach of democratizing AI development, conversation, and dialog. XOXCO had raised a rather modest $1.5 million prior to its acquisition.

It also improved its gaming offering with the acquisitions of inXile Entertainment and Obsidian Entertainment. inXile is known as the developer of Wasteland 2 and Torment: Tides of Numenera. inXile was founded in 2003 and has a talented and experienced team to produce quality games for home and portable video game systems. It had raised $11.8 million prior to the acquisition at an undisclosed valuation. Obsidian Entertainment was founded in 2013 and has been focused on developing role-playing games for personal computers. It is best known for developing Fallout: New Vegas, the Pillars of Eternity games and Knights of the Old Republic 2. Prior to the acquisition, Obsidian Entertainment had raised $4.9 million at an undisclosed valuation.

It is not just smaller players that Microsoft has added to its portfolio. In October last year, it announced the $400 million acquisition of Glint for its LinkedIn service. Redwood City-based Glint was founded in 2013 and is a people success platform that leverages real-time people data to help drive employee engagement and employee development among organizations. Glint uses intuitive design, analytics, and intelligence to help improve employee happiness at the workplace. Prior to the acquisition, Glint had raised $79.5 million at undisclosed valuations.

Microsoft has been focused on both organic and inorganic growth. The addition of smaller, capital-efficient or bootstrapped startups helps it get niche technology that complements its existing offerings. Some of these have helped it add more capabilities to the Azure platform. But it would need many more such plays to ensure it bridges the gap with AWS faster. What such acquisitions do you recommend for Microsoft?

Microsoft’s stock is currently trading at $106.38 with a market capitalization of $816.7 billion. It had climbed to an all-time high of $116.18 in September last year. The stock was trading at a year low of $83.83 in March last year.

 

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