Key takeaways:

• Cloud revenue growth rates play a significant role in valuations for tech giants like Microsoft and Alphabet, with the segment accounting for an increasing portion of overall earnings

• Surging interest in generative artificial intelligence (AI) is expected to underpin future demand for cloud services

• Amid signs of customer ‘optimisation’, and cloud providers investing heavily to develop secure services, price creep remains a key consideration

In light of this week’s earnings from Microsoft (NASDAQ: MSFT) and Alphabet (NASDAQ: GOOGL), investors are suddenly focused on one thing – the cloud.

Based on forecasts from Grand View Research, the global cloud computing market was valued at around US$484 billion last year, with the industry set to grow at a compound annual growth rate (CAGR) of 14.1% from 2023 to 2030. 

A number of tailwinds are expected to contribute towards growth across the segment, with some of the market’s biggest tech stocks being pioneers in this space. From the likes of Amazon (NASDAQ: AMZN), to Microsoft and Google parent company Alphabet, the trio control an estimated two-thirds market share across the industry.

In a sign of how growth within this segment is becoming an increasingly important litmus test for stock valuations, and the market at large, the responses to earnings from Microsoft and Alphabet paint a compelling story, while also offering handy insights for investors.

Earnings Recap

Alphabet 

On the back of its third-quarter earnings, Alphabet shares recorded their steepest drop since October 2022. GOOGL shares tanked almost 10%, wiping more than US$160 billion off the tech giant’s market cap.

While Alphabet topped revenue and earnings per share forecasts, it was the company’s cloud division that fell short of expectations and ultimately weighed on the share price.

Highlighting just how much of a battleground cloud computing is shaping up for the tech sector, investors turned their backs on headline revenue growth of 22% within the Google Cloud unit. That’s because total revenue, at US$8.41 billion, fell short of Wall Street’s estimates for US$8.64 billion.

Given the rate of growth in the prior quarter was 28%, observers appear concerned by the deceleration, not to mention commentary by Alphabet’s CFO that suggested clients were tightening their spending and the growth rate “reflected the impact of customer optimization efforts”.

Microsoft

On the other hand, Microsoft suffered no such issues. In fact, its shares were trading higher in the wake of its own quarterly report, where cloud growth was the catalyst for the market’s positive response.

Unlike Alphabet, Microsoft’s cloud revenue growth actually accelerated during the most recent quarter. Microsoft’s Azure division grew by 28% throughout the period, which was one percentage point higher than the preceding quarter.

This was the first time in two years that Microsoft reversed a downwards trend in cloud revenue growth. Up until this result, each of the last eight quarters saw cloud growth decelerating.

Digesting the results, MSFT shareholders will be wondering if the company managed to eke out some market share from its nearest rival, and whether it might be sustainable, because management also flagged expectations that client spending ‘optimisation’ is tipped to continue throughout the year.

Key Lessons for Investors

Cloud Revenue Remains a Key Growth Lever

In the case of Alphabet’s results, the 22% growth rate in cloud revenue was more than double that across the rest of the company. That is to say, despite a slowdown compared with the prior quarter, the segment is still the engine room for the tech giant.

For Microsoft, its Azure and other cloud services division grew at a faster rate than any other segment across the business. This isn’t a new phenomenon either, with this segment underpinning growth across every quarter for several years now.

However, an emerging reality that cloud providers such as MSFT and GOOGL will need to deal with is the fact that some enterprises are looking for multicloud solutions. In other words, cloud solutions that are facilitated through multiple providers. 

Historically, vendors haven’t been motivated to encourage interoperation between cloud services, but it is a new demand that goes head to head with the goal of safeguarding market share. There are recent examples of this, including Microsoft’s collaboration with Oracle (NYSE: ORCL), and Google’s deal with NetApp (NASDAQ: NTAP).

Generative AI Changes Everything 

With artificial intelligence increasingly being embraced as a key differentiator for the provision of online services, hyperscalers are investing heavily to develop unique large language models (LLMs) and platforms supportive of generative AI applications.

However, at the heart of these efforts, cloud features like storage and computing are the backbone for generative AI to function and operate. That means cloud providers will need to seek out ways to differentiate themselves from their peers in order to carve out or protect market share.

Microsoft has a head start in terms of AI capabilities and has even integrated this with cloud offerings for enterprises, while the likes of Google and Amazon are investing heavily to build chips, finetune their own LLMs, and launch AI-optimised services. In this sense, generative AI is arguably the most pivotal trend in the cloud market at this time, a differentiator, and driver for cloud revenue growth.

Cloud Pricing Decisive Amid Heavy Investment

At the start of September, computing heavyweight IBM (NYSE: IBM) announced that it will pass on a major price increase for its cloud services. Starting January 2024, IBM’s cloud services, including infrastructure-as-a-service (IaaS) and platform-as-a-service (PaaS) offerings, will cost up to 26% more.

That follows recent pricing adjustments from Microsoft, and even Salesforce (NYSE: CRM), with the latter pushing through its own price hike – its first in seven years.

What is clear is that cloud providers such as MSFT and GOOGL, already mindful of client expenditure ‘optimisation’, will need to strike the right balance in choosing to pass on higher costs to maintain or arrest any deceleration in cloud growth rates. This comes against a backdrop where said companies are investing billions of dollars to support generative AI capabilities, and also tighten cloud security.

Over the US summer, hackers accessed the email accounts of key US government officials. The incident, which saw a breach of Microsoft’s cloud network, has raised the pressure on major cloud names to do more in the name of data integrity.

Already a defining trend for the tech sector, the cloud computing industry is only gaining more time in the spotlight as titans like Microsoft and Alphabet duke it out to defend their territory and shield their profiles as high-growth stocks.