26 April 2022

    Sleeping Digital Giant

    Daniel Moser

    Investment Analyst

    Email Daniel
    Daniel Moser

    Investment Analyst

    Email Daniel

    “This is a software-powered world.” – Satya Nadella, CEO Microsoft

    The move to the cloud is a secular trend that enterprises all over the world are currently embracing. The necessity of working from home, brought on by the pandemic, has only accelerated this trend. There are few better positioned to take advantage of this trend than Microsoft through its Azure business, which is why we have recently added the company to our International Growth portfolio.

    Not your parent’s Microsoft

    Most of us know Microsoft for its classic software products that we likely use every day such as Word, PowerPoint, and Excel.  But quietly the company has pivoted away from purely providing productivity software products to dominating the cloud computing and services market through its Azure franchise.

    The genesis

    Satya Nadella became Microsoft’s 3rd CEO in early 2014 and had a clear vision on how he wanted Microsoft to evolve; to become a leader in cloud computing. This meant moving Microsoft’s existing products from a licencing model to a subscription style Software-as-a-Service (SaaS) model, and also opening its datacentre network to its numerous enterprise customers. The benefit for customers is many-fold. It allows them to access institutional-grade computing power and services off-premise, at a lower price point. It also eliminates the need to continuously invest in upgrading expensive and less efficient on-premise servers and computing. A shared win between Microsoft and its customers.

    What is cloud computing?

    Cloud computing is essentially streaming for software, like what Netflix is to video consumption. Microsoft describes it as follows:

    Cloud computing is the delivery of computing services including servers, storage, databases, networking, software, analytics, and intelligence - over the Internet (“the cloud”) - to offer faster innovation, flexible resources, and economies of scale. You typically pay only for cloud services you use, helping you lower your operating costs, run your infrastructure more efficiently, and scale as your business needs change.

    The global move to the cloud is an exciting trend that will extend over business cycles. We believe the cloud trend is a very large opportunity that is still in the early stages of its lifecycle. Experts estimate the cloud computing market to be worth between US$1 trillion and US$4 trillion annually. There are few companies globally that have the resources to compete at this scale and pace, creating a winner-takes-most competitive dynamic and moat. This sets the scene for Azure to grow and prosper for many years to come.

    Mesmerising growth and scale

    Azure and Microsoft’s broader Commercial Cloud business’ growth has been stunning. From a standing start in 2014, 2021 revenues for Azure were roughly US$30b and the wider Commercial Cloud business were US$69b, both continuing to grow quickly irrespective of scale.

    Today, Azure is the number 2 player in cloud computing behind Amazon Web Services (AWS) and well ahead of 3rd place, Google Cloud Platform (GCP). As the cloud market matures it seems that these three horsemen will be the dominant players and take a lion’s share of the market globally.

    Cloud Provider Market Share Trend (IaaS, PaaS, Hosted Private Cloud)
    Source: Synergy Research Group

    Whilst Microsoft is currently second behind AWS in terms of market share, it is quickly catching up. This is primarily due to its strong existing relationship with practically every large enterprise globally through existing software products, and its roughly 60% market share in the on-premise server and compute market. So, as companies migrate to off-premise and “cloudify” themselves, Microsoft is the natural cloud-provider option for many enterprises. The conversion of its existing customer base alone is expected to provide years of growth for Azure.

    Hiding in plain sight

    In all, Microsoft is a fantastic business with world-class franchises, which continues to gain significant share in the cloud computing market on top of ongoing success with its well-known  core software products. As Microsoft adds more strings to its bow the company further entrenches itself with customers globally and is often an IT department’s most critical vendor. These factors combined with being highly profitable is a rare combination and makes Microsoft one of the highest-quality global businesses, which is becoming more valuable as each day passes.

    The market volatility at the beginning of 2022 presented the team the opportunity to add Microsoft to our International Growth portfolio at an attractive valuation and we are excited to see Microsoft continue on its growth trajectory for many years to come.