- AWS and Microsoft Azure fall below expectations
- Microsoft expects growth to slow again next quarter
Cloud computing growth is slowing faster than analysts expected, raising fears that the divisions held up as major profit drivers for some tech giants might not be impervious to the global slowdown. Amazon (US:AMZN) and Microsoft’s (US:MSFT) cloud services performed below analyst expectations in the third quarter: Amazon Web Services’ (AWS) sales rose 27 per cent year on year to $20.5bn (£17.9bn), below analyst expectations of $21.2bn. It was also AWS’s slowest ever year-on-year growth figure. Quarter-on-quarter growth was 4 per cent.
The cloud sector had been billed as recession resistant because of the recurring nature of the revenue. However, customers are also billed on usage, which means they can change their spending on a quarterly basis. “With the ongoing macroeconomic uncertainties, we’ve seen an uptick in AWS customers focused on controlling costs,” said Amazon chief financial officer Brian Olsavsky.
Microsoft’s cloud division, Azure, also disappointed. Revenue growth was 35 per cent, below analyst expectations of 36.5 per cent. The company is now forecasting that sales growth will fall again in the next quarter as economic conditions start to tighten. “We expect Azure revenue growth to be sequentially lower by roughly five points on a constant currency basis,” said Microsoft chief financial officer Amy Hood.
Google Cloud was the only major cloud computing service to beat expectations. Parent company Alphabet (US:GOOGL) reported that Google Cloud’s revenue was $6.89bn for the third quarter of this year. That equates to annual growth of 38 per cent and beat analyst expectations of $6.68bn.
Profit margins are also slipping as the companies invest in new hardware and new technologies. AWS, the most mature of the cloud businesses, is still hugely profitable with an operating margin of 26 per cent. However, this slipped from 30 per cent last year. At Google, meanwhile, Cloud operating losses widened from $644mn to $680mn. Competition is great for customers but less good for margins.
Where's the rain?
Cloud customers are businesses that previously ran servers on site, but now effectively rent space on a tech provider’s own services. Outsourcing is much cheaper and gives access to much more computing power than can be scaled up and down as needed. For example, the big data crunching needed for machine learning can only be done in the cloud. Microsoft is integrating OpenAI’s new text-to-image generator DALL-E 2 into its Azure OpenAI Service.
The other benefit for customers is they get cutting-edge cyber protection, which is becoming increasingly important. In September, Google Cloud completed the $5.4bn acquisition of cyber security business Mandiant.
The benefits of cloud computing meant many analysts expected revenue growth to continue unabated until almost all companies had moved from on-premises systems. However, the growth slowdown is not confined to the past quarter (see chart). Analysts now forecast AWS growth to slow to 23.4 per cent in the three months to December 2023, down 16 percentage points from two years earlier.
Amazon, Microsoft and Google are effectively a cloud computing oligopoly because the huge investment needed creates barriers to entry. Their fortunes can therefore be seen as a proxy for the wider software space. Bytes Technology (BYIT), a provider of IT software solutions, generates most of its revenue from helping companies with their cloud transition. “You can use Microsoft Azure’s growth as a proxy for us; if it is growing at 40 per cent, we should at least be able to hit double-digit growth,” said Bytes chief executive Neil Murphy last week.
Chip designers also make a large amount of money selling microprocessors to specialist data centres. Intel (US:INTC) makes 33 per cent of its server revenue from cloud-related sales, up from 29 per cent in 2016. Meanwhile, data centres now make up 39 per cent of Nvidia’s (US:NVDA) revenue. Both these companies would see a slowing of growth if demand for cloud servers weakens.
The reality is that cloud computing will be a large part of our future and growing sales at over 20 per cent a year while the rest of the world economy shrinks is not to be sniffed at. However, given the valuations many of these companies were trading at, expectations for their cloud divisions were sky high. After moderating expectations, investors are less likely to be caught by a nasty surprise.
