As Amazon and Microsoft prepare to report earnings this week, a regulatory cloud hangs over Amazon even as Microsoft appears to enjoy clear skies.
A couple decades ago, Amazon (AMZN) was the young whippersnapper with soaring shares while Microsoft (MSFT) was the battered veteran whose stock price struggled amid regulatory concerns.
In some ways, the tables have turned for the two companies, though now they’re both well seasoned. These days, it’s AMZN’s stock spinning its wheels under government scrutiny, while MSFT shares trade near record highs as the company seems to enjoy some immunity from the regulatory fever sweeping through Washington.
Shares of MSFT are up 31% over the last year, well ahead of the broader market. Meanwhile, AMZN shares are about flat from a year ago and way below all-time highs above $2,000. As of Monday, MSFT and AMZN are numbers two and three respectively in the battle for largest company in the world by market capitalization, with Apple (AAPL) having recently regained the top spot.
MSFT also crossed a Rubicon in Q4 of its 2019 fiscal year, which ended in June. That was the first quarter where MSFT generated as much revenue from running software in its own data centers—including cloud offerings like Azure and Office 365, as well as LinkedIn, Bing, GitHub and Xbox-Live—as it did from software licenses and upgrades, hardware and professional services, according to research firm CFRA.
That’s a huge symbolic win for MSFT, which more than tripled its share value over the last five years in part by growing its cloud presence and relying less on traditional software offerings. It’s not often when you see a company that’s been public for more than 30 years and once faced the possibility of being broken up generate a second life this way. Its shares have been well rewarded, reaching an all-time peak of $142.37 in September. See figure 1 below.
As CFRA notes, the ability to pivot isn’t the only thing in MSFT’s favor. By focusing on the cloud and growing its business there, it also can likely improve its margins. Another big advantage MSFT arguably has now is that unlike AMZN and other FAANG companies, it seems to be flying under the radar for the moment when it comes to government pressure.
“As companies such as Amazon and Google (GOOGL) are battered with antitrust investigations and privacy mishaps, Microsoft can avoid playing defense — and make a positive pitch to work with government,” the Washington Post noted earlier this month.
Earnings season comes around again even as MSFT and AMZN compete for a $10 billion Department of Defense contract called joint enterprise defense infrastructure, or JEDI. The contract was originally going to be awarded over the summer, according to The New York Times, and is meant to bring the military into the modern era of cloud computing.
However, the decision didn’t happen. Instead, the Pentagon delayed so it could look into whether AMZN was receiving favor from the department, the Washington Post reported. Timing is unclear now, but some analysts think MSFT might have an advantage because unlike AMZN, it hasn’t been under the regulatory microscope lately.
MSFT, which reports fiscal Q1 earnings on Wednesday after the close, hopes to see the government choose its Azure cloud computing service, while Amazon is trying to get the bid directed to its Amazon Web Services (AWS). The earnings calls could be important for investors seeking an update on the project, though it’s still probably a waiting game while the government looks at everything.
AMZN, which is expected to report earnings after the close on Thursday, has really hit a roadblock as far as its stock price. Shares recently were down 6.9% from the end of Q2. It’s tempting to blame that on weakness in the Consumer Discretionary sector, but while that sector hasn’t been burning up the road, it is up 2.6% over the same period. Instead, some analysts think regulatory concerns might be to blame. There’s fear that politicians on both sides of the aisle could be making companies like AMZN the bogeymen ahead of next year’s election.
The Technology sector, where MSFT shares live, is up 4.4% since the end of Q2. MSFT shares’ performance over that period exactly matched the sector’s as of last week.
MSFT and AMZN arguably dominate the growing cloud infrastructure, but recent fast growth leaves some analysts wondering how much more they can deliver.
Before answering that question, it’s worth noting that another cloud giant—IBM—had its shares taken to the woodshed last week after reporting weaker than expected revenue. IBM’s Global Technology Services segment, of which cloud services is part, fell 5.6% from the year-ago period. Do IBM’s results bolster the argument that, having plucked the low hanging fruit from cloud services, revenues are going to be harder to come by? Or is it that IBM seems to be falling behind in the race between it, Azure and AWS?
For its part, MSFT’s Azure public cloud platform saw revenue increase 64% year-over-year in fiscal Q4, which sounds great on the surface. However, the number might have disappointed some investors because it rose 73% in fiscal Q3, which itself was a fall from fiscal Q2.
Sequential Azure growth is likely to get a close eye this time out, but often when a product spends more time on the market, it gets harder to keep generating the kind of early growth Azure enjoyed. The law of large numbers comes to mind.
Instead of just focusing on Azure growth, it might be helpful to hear what MSFT executives say on the call about new contracts for the product. Last time out, MSFT announced more large and long-term contracts for Azure, maybe a better sign than just a raw growth number if the company keeps this up.
As a reminder, cloud computing provides a way for businesses to access servers, storage, databases and application services over the Internet. A company like AMZN or MSFT owns and maintains the network-connected hardware required for these services, while their business customers can use what they need through the web without having to build or buy expensive hardware platforms.
MSFT is much more than the cloud, of course. In fiscal Q4, the company’s More Personal Computing segment, which includes Windows, Surface, Xbox and search, outpaced third-party consensus for revenue.
That was also the case with the Productivity and Businesses segment, which includes Office, Dynamics and LinkedIn. One possible concern here is declining sequential revenue growth over the last several quarters from Office 365 Commercial.
To round things out, the Intelligent Cloud business segment—which includes the Azure public cloud, Windows Server, SQL Server, Visual Studio, GitHub and consulting services—also beat analysts’ revenue estimates for the hat trick in fiscal Q4.
Arguably, that means MSFT was firing on all cylinders as it wrapped up the old fiscal year. So what does the company expect for fiscal Q1?
In its fiscal Q4 earnings call, MSFT said it expects fiscal Q1 revenue of between $31.7 billion and $32.4 billion. That would be just over 10% revenue growth at the mid-point of that range, down from 12% in Q4. The company has had nine-straight quarters of double-digit annual revenue growth, according to CNBC. The question is whether the slight slip in growth the company forecast is something investors need to worry about.
The flip side, some analysts point out, is that MSFT faces a tough comparison to fiscal Q1 a year ago, when revenue rose 19%.
Last time out, MSFT reported earnings and revenue that beat Wall Street’s estimates. Its guidance also was above where analysts had expected. We’ll have to see if MSFT can deliver a repeat on Wednesday.
One question for both MSFT and AMZN is whether cloud growth this spring and summer might have gotten hurt by the slowing global economy. Both AMZN and MSFT are likely to be asked about the U.S./China trade battle on their earnings calls. Both companies have huge businesses across the world and might be able to provide perspective on the economic impacts.
Another potential topic MSFT might be asked to address on the call is capital expenditure levels, which reached a four-year high in fiscal Q4.
When MSFT releases results, it is expected to report adjusted EPS of $1.25, up from $1.14 in the prior-year quarter, on revenue of $32.23 billion, according to third-party consensus analyst estimates. That revenue would represent 10.7% growth from a year ago.
Options traders have priced in approximately a 5% stock price move in either direction around the upcoming earnings release, according to the Market Maker Move indicator on the thinkorswim platform. Implied volatility was at the 29th percentile as of Monday morning.
Looking at the Oct. 25 weekly option expiration, put options have been active at the 133 and 137 strikes, but the call side has seem more activity, with heavy concentration at the 140 and 142 strikes.
Note: Call options represent the right, but not the obligation, to buy the underlying security at a predetermined price over a set period of time. Put options represent the right, but not the obligation to sell the underlying security at a predetermined price over a set period of time.
AMZN’s earnings come as the company continues to wrestle not only with regulatory concerns but also with bad publicity after recent media reports.
Last month, The Wall Street Journal reported that AMZN has adjusted its product-search system to more prominently feature listings that are more profitable for the company. The move, which the newspaper said had been contested internally, could favor Amazon’s own brands.
The issue is tied into the company’s regulatory issues because the U.S. and the European Union are examining Amazon’s dual role—as marketplace operator and seller of its own branded products—the article continued. An algorithm skewed toward profitability could steer customers toward thousands of Amazon’s in-house products that deliver higher profit margins than competing listings on the site.
AMZN responded that it hasn’t changed the criteria it uses to rank search results to include profitability, but it’s possible this issue could come up on the company’s earnings call. In Washington, some politicians are calling for changes in antitrust law to account for big technology companies’ clout. Democratic presidential candidate Sen. Elizabeth Warren has singled out AMZN, saying it hurts small businesses.
Earlier this year, Warren proposed breaking up big companies like AMZN and Facebook (FB). Warren and other politicians have also spoken out against cities and states offering tax incentives for AMZN to locate its operations there.
If Warren’s strength in the polls continues into next year’s early primaries, it might be interesting to watch the possible impact on AMZN and other so-called “FAANG” stocks like Facebook and GOOGL that frequently come up in the campaign. It’s possible some of the flatness in AMZN’s share price might already be a reflection of nerves ahead of 2020.
Turning away from regulatory issues, AMZN is continuing to beat the drum of one-day delivery for Prime customers, which it announced back in April. Just over the last week or two, trade media reported that the company has started to make even its lowest-priced items part of that program. The idea is to allow people to buy items like dental floss and get them the next day, essentially helping AMZN replace the traditional corner drug store. There are a lot of logistical issues around making one-day delivery work, so expect it to be a topic on the call.
Last time out, AMZN’s quarterly results were mixed. The company beat third-party consensus for revenue but missed on earnings. That raised the question in some analysts’ minds whether AMZN is getting hurt on the margins by the money it’s investing on single-day delivery. That’s possible, but maybe the company thinks in the long run it can make up for that by pulling in more revenue once Prime customers can get their items the next day.
During the Q2 call, AMZN CEO Jeff Bezos said one-day delivery for Prime customers was available on 10 million items, “and we’re just getting started.” Look for a potential update on that number on Thursday.
Amazon’s cloud service, like MSFT’s, has been slowing in sequential growth. It rose 37% in Q2, down from 41% in Q1. That’s a trend to watch this time out. In AMZN’s case, one possible question is whether the slower growth reflects competition from MSFT.
Looking back at guidance for Q3, AMZN said net sales are expected to be between $66 billion and $70 billion, or to grow between 17% and 24% compared with Q3 2018. Operating income is expected to be between $2.1 billion and $3.1 billion, compared with $3.7 billion in third quarter 2018.
When AMZN releases results, it's expected to report adjusted EPS of $4.60, down from $5.75 in the prior-year quarter, on revenue of $68.8 billion, according to third-party consensus analyst estimates. That revenue would represent 21.6% growth from a year ago.
The options market has priced in approximately a 3.2% stock price move in either direction around the upcoming earnings release. Implied volatility was at the 22nd percentile as of Monday morning.
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