The slowdown has come for the cloud business

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Wednesday 26 October 2022

Even cloud giants like Microsoft cannot avoid the economic slowdown

The economic slowdown has come for the big cash cows of tech companies: the cloud companies that provide their customers with low-cost computing power and applications.

Microsoft (MSFT) reported Tuesday that its all-important Azure cloud division will see slower-than-expected growth this quarter. On the same day, Alphabet (GOOG, GOOGL) reported that the growth of its Google Cloud platform slowed from 44% in Q3 2021 to 37% in Q3.

Amazon (AMZN) is expected to experience 33% growth in its AWS segment when it announces its earnings on October 27. This would mark a decline from the 39% growth recorded in the same quarter last year.

“We are seeing some fiscal pressure on the corporate side,” Piper Sandler equity research analyst Brent Bracelin told Yahoo Finance. “We certainly wouldn’t say that enterprise software, the cloud is macro immune and we’re starting to see cracks.”

Cloud growth was lightning fast during the pandemic. Its slowdown means companies across various industries are slashing budgets and looking for ways to save in near-record inflation, rising interest rates and recession fears. Those cuts are hitting Big Tech where it hurts.

The cloud is undergoing a huge test

Cloud computing services generally help businesses save money. Instead of having to buy their own software or run their own servers, businesses of all sizes can turn to cloud service providers to offer those services over the web.

The cloud segments of Amazon, Google, and Microsoft also offer what’s known as a pay-as-you-go business model, which means their customers only pay when they use cloud services. Think of it as renting a car when you need to travel somewhere instead of owning a car. Instead of paying for monthly insurance and repairs, you only pay for the time you are using the car.

Microsoft has reported that its cloud services business will see slow sales growth this quarter. (Photo AP / Elaine Thompson, file)

Amazon and Microsoft have been most successful with their cloud strategies. They are the number one and two cloud providers in the world, with Amazon holding 34% of the market and Microsoft controlling 21% in the second quarter. Google, which is still developing its service, holds 10% of the global market.

Margins on cloud businesses are incredibly high, with Microsoft reporting margins of up to 73% on the entire cloud segment in the last quarter and Amazon reporting margins of 29% for its AWS platform in the second quarter of 2022.

Investors have seen these numbers and piling up in Amazon and Microsoft before and during the pandemic with the promise of continued growth through the cloud. But that growth is being crushed.

“There is clearly a macro uncertainty. And no one will be immune from it. Not even some sort of 800-pound gorilla like Microsoft, “RBC Capital Markets equity analyst Rishi Jaluria told Yahoo Finance.

And that scared the investors. Shares of Microsoft were down about 6% in the middle of the day on Wednesday. Shares of Amazon fell 3.8% and Alphabet shares fell 7.8%, although they were also hurt by poor YouTube ad sales.

Cloud computing could come back bigger than before

As cloud revenue is slowing at Microsoft and Google, segments could see their growth revert to previous highs when the economy turns upside down. Their consumption-based business models allow companies to easily jump and return when economic conditions allow.

Microsoft, in particular, could benefit from the broader retirement and eventual return to growth.

“Microsoft has the ability to consolidate budgets. Many companies use 100 different software vendors or even 1,000 different ones [software as a service] applications, “explained Jaluria.

Microsoft could tell its customers that it can offer the same types of apps and can provide them alongside its cloud services for a better price. The bad news? It is not yet known when the recession will end. For now, companies will have to get used to slower growth than in the times of the Big Tech boom.

Of Daniel Howley, technical editor of Yahoo Finance. Follow him @Daniel Howley

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