Microsoft Faces the Highest Bar in Tech

Microsoft’s dim forecast three months ago gave investors an early heads-up, and its plan to join other big techs in a recent layoff wave seemed to drive the point home further. “We will have to do more with less,” Chief Executive Satya Nadella told the World Economic Forum in Davos, Switzerland, last week, before the company announced plans to cut 10,000 jobs from its payroll.

That would appear to set a low bar for the coming report. Analysts estimate that Microsoft’s revenue for the December quarter grew only 2.7% year over year to $53.1 billion—the company’s lowest growth rate in nearly six years. Growth for the company’s crucial Azure public cloud service is expected to hit a record low 30.5% year over year—a deceleration of nearly 5 percentage points from the September quarter.

Revenue in the personal-computing segment that includes the Windows business is expected to slide 14% year over year—a sharp reversal from the 15% growth logged in the previous year’s December quarter, when the company was still benefiting from the pandemic-induced PC sales boom.

Microsoft’s forecast for the March quarter and its outlook for the rest of the year will prove essential. Wall Street expects growth to pick back up in the second half of the calendar year. More crucially, Microsoft is expected to maintain annual operating margins above 40%—the highest among the big tech peers including Apple, Amazon.com and the parent companies of Google and Facebook.

Wall Street’s projected operating margin of about 41% for Microsoft in calendar year 2023 is nearly 5 percentage points higher than what the company averaged over the five-year period running from 2017 to 2021 and is a much larger margin improvement than what the other four big techs are expected to show over the same period.

Can the company pull that off? Maybe. Corporate tech officers are indeed cutting back their spending plans; Gartner projected that worldwide IT spending will grow 2.4% this year—less than half the growth rate the market research firm predicted three months ago.

Microsoft is still in a prime position given that it runs the second-largest public cloud service and owns many of the software tools and applications that are still central to business life. A recent survey by Morgan Stanley found that 38% of chief information officers rank Microsoft’s Azure as their preferred cloud provider, compared with 31% for Amazon’s larger AWS service.

But Microsoft still has a lot of exposure to the PC market, which is in free fall. IDC reported earlier this month that PC unit sales slid 28% year over year in the fourth quarter—the biggest drop that the market research firm has seen in years—and doesn’t expect recovery for the industry until 2024.

Analyst John DiFucci of Guggenheim downgraded Microsoft to a sell rating on Jan. 17, citing both the PC slowdown and Microsoft’s strong exposure to small businesses, which he says “typically fare worse than enterprises in a macro slowdown.”

Even cutting 10,000 workers might have a limited impact. That is only one-quarter of the employees Microsoft added in the fiscal year that ended in June 2022, which included the company’s acquisition of Nuance Communications. In his email to employees announcing the layoffs, Mr. Nadella made it clear that “we will continue to invest in strategic areas for our future,” which includes the adoption of potentially expensive AI technology like ChatGPT across the company’s products.

Microsoft’s highly successful transition into a cloudcentric company has deservedly earned it the faith of investors. Its ability to maintain high margins in the face of a possible recession will test that faith.

Write to Dan Gallagher at [email protected]