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THE BROAD VIEW

Microsoft, tech's quiet giant, keeps its focus on the cloud

CEO Satya Nadella is working to keep up a steady flow of cloud deals, seeking to centre Microsoft's strategy on Web services and narrow the gap with market leader Amazon.com

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Last week, Microsoft announced a deal with the Providence St Joseph Health system that is geared towards collecting health data from different sources in one place, using AI to improve results for patients and connecting more than 100,000 caregivers to one another.

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IF you followed the US Congress' scrutiny of the technology industry this week, you would think that Amazon, Google and Facebook are the biggest tech firms around. But Microsoft is the sector's quiet giant. It is not only the largest tech company, but it is the largest publicly traded company of any kind, with a market capitalisation of more than US$1 trillion.

The success continued in the most recent quarter, Microsoft said on Thursday. The company reported that its sales grew 12 per cent, to US$33.7 billion, and it had US$13.2 billion in profits during that period, aided by US$2.6 billion in tax benefits, beating analyst expectations. Analysts had expected the company would have US$32.8 billion in sales and US$9.4 billion in profit, according to FactSet.

The strong results indicate large companies are still investing in new technology, shrugging off concerns of a downturn or trade war.

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"The biggest debate is at US$1 trillion, how can you get bigger from here?" said Jennifer Lowe, an analyst at the investment bank UBS.

What's the main driver of Microsoft's business?

At its core, Microsoft's primary customers are other businesses and organisations, and the company is betting its future that they will keep moving their tech needs into the cloud.

Most investors keep a close eye on how quickly Microsoft's core cloud-computing product, Azure, has grown.

CEO Satya Nadella is working to keep up a steady flow of cloud deals, seeking to centre Microsoft's strategy on Web services and narrow the gap with market leader Amazon.com Inc. As more companies move to the cloud and upgrade ageing software, they're signing up for Azure and newer products like Microsoft 365 - a package of Office 365 cloud software, Windows 10 and security programmes.

Many investors hope to see Azure have a growth rate over 70 per cent compared with the previous year, maintaining its rapid pace of expansion even as the business gets bigger. In the most recent quarter, Azure grew 68 per cent.

Ms Lowe, who estimated Azure brought in roughly US$13 billion in annual sales, said: "That pace of growth, at that scale, is pretty unprecedented." Amazon, the cloud-computing leader, is the provider of choice for digitally native companies like Netflix, but Microsoft has found traction with traditional large corporations and organisations, Ms Lowe noted.

"Everything has been going well for them," said Sid Parakh, a portfolio manager at Becker Capital Management, which counts Microsoft as its biggest holding. "It's the structural winner right now - as more and more companies move to the cloud, it's largely Amazon and Microsoft in the running for those deals."

Commercial cloud revenue rose 39 per cent from a year earlier to US$11 billion. Profit margins in the business widened by six points to 65 per cent. Sales of Office 365 software to businesses jumped 31 per cent. Azure cloud sales rose 64 per cent, compared with 73 per cent growth in the previous quarter and 76 per cent in the one before that. That continued deceleration has caused some concern among investors - Azure growth was routinely more than doubling as recently as two years ago. Still, swelling profit margins in cloud have helped to offset those worries.

Why is the cloud business growing?

Microsoft has been pushing the adoption of cloud service beyond the simple storing of information in remote data centres. It has persuaded corporate customers to employ cloud computing to transform how they do business using tools like artificial intelligence (AI), and to connect workers on retail sales floors and assembly lines to corporate technology.

In traditional set-ups, when companies ran their own servers, it was hard to upgrade and add new functions. "Every time you wanted to do something new, you had to buy new hardware," noted Mr Parakh. "With cloud, you have as many capabilities as you want overnight."

One Microsoft metric - server products and cloud services revenue growth - provides clues about whether that approach is taking hold. It lumps together sales for traditional data centres and cloud services, and last quarter it was up 29 per cent over the previous year. That it is growing at such a solid clip suggests the cloud business is not just taking old revenue and moving it online.

Last week, Microsoft announced a deal with the Providence St Joseph Health system that is geared toward collecting health data from different sources in one place, using AI to improve results for patients and connecting more than 100,000 caregivers to one another. This week, it announced a deal with AT&T.

That wonky metric is also a sign of what is known as a hybrid approach to cloud computing, where big organisations keep some information on their own servers and some in the cloud, using a single set of tools to work on it all. Such an approach eases companies' transition to the cloud, and is a particular strength for Microsoft.

Worldwide public-cloud services sales are expected to grow 17.5 per cent this year to US$214.3 billion, according to Gartner Inc. In the infrastructure part of the market, Amazon and Microsoft are increasingly pulling away from other competitors - although Azure remains several times smaller than Amazon Web Services. Meanwhile, Microsoft's Office cloud business puts it in the lead in area of cloud-based applications.

What about Microsoft's consumer business?

Microsoft still sells Windows and Office software to consumers, and some of its Surface tablet and laptop sales also target individual customers. The unit known as More Personal Computing, including Windows software, Surface hardware and Xbox gaming products, saw revenue climb 4 per cent to US$11.3 billion.

Global shipments of personal computers (PCs) increased 1.5 per cent in the second quarter, Gartner said, fuelled by businesses upgrading to the latest Windows operating system. Support for Windows 7 is ending in January, meaning companies need to upgrade to Windows 10. The older software's expiration is also helping boost sales of the Microsoft 365 bundle as the company persuades customers to switch to Internet-based subscriptions rather than one-time licences.

Sales of Windows to PC makers were better than expected, rising 9 per cent overall and 18 per cent for the pricier professional editions, far outpacing the overall PC market.

But the most interesting part of its consumer business is gaming. The past fiscal year has been odd for Microsoft's gaming business, in part because it is overdue for a new Xbox gaming console. In the long term, Microsoft is working to become a hub for players to stream games live from the cloud. It went so far as to enter a partnership with Sony, which makes a competing console, under which the companies will work on online entertainment together.

A year ago, Microsoft's gaming business did particularly well on the success of Minecraft. The company cautioned investors that this past quarter, gaming might not be as strong. Indeed, it reported that gaming revenue declined 8 per cent. NYTIMES, BLOOMBERG