Amazon () has some 33% of the cloud market share. However, Microsoft (), with only 13%, is gaining ground on its biggest rival in this sector. The sector is new and therefore, difficult for analysts to call an accurate number prior to the earnings release.
Microsoft has surprised with its earnings the past four quarters with large subsequent stock moves thereafter. But, what I think is going to be the bigger question is market share percentage versus actual revenue earned. The total pie for cloud computing is expected to hit $260 billion by 2021. While both companies have been growing their respective businesses, the market share increases they have been gaining is coming from smaller players. Eventually, that will dry out and any gains will be from directly poaching business from each other.
Microsoft has its earnings announcement after the bell on Wednesday. Any news from Microsoft gaining or ceding ground in this race could create a substantial market mover. The question then is which company gains or loses, and at the expense of whom? The next question then becomes: what happens to the stock thereafter?
Here is a look at the two companies’ respective stock movements, 1-year performance on a percentage basis.
Microsoft versus Amazon 1-year growth rate
Two behemoths compete in the same category
Currently, Amazon Web Services holds 33% market share of infrastructure for cloud. But, Microsoft has been gaining ground lately. Here is a chart showing the share of revenue on a percentage basis for the various competitors:
Looking at the chart, Amazon has maintained an ~33% market share throughout this time, with IBM (), Google () (NASDAQ:), and Alibaba () gaining some ground but lower in size. However, Microsoft is increasing significant share on a percentage basis. But, those gains are not at the cost to Amazon, whose 33% is the same throughout. When I first looked at the chart, I wondered who was losing ground to Microsoft? The article cited above pointed that out:
Microsoft, Google and Alibaba have all substantially grown their market shares, but this has not been at the expense of AWS. It is the small-to-medium sized cloud operators who collectively have seen their market shares diminish. Meanwhile IBM market share has been relatively stable at around 8%, thanks primarily to its strong leadership in hosted private cloud services.
There is only so much ground that the smaller players can cede before they hit zero. Then, any shifts in the realm will come from the bigger players losing market share to each other. That is when the real horse race begins.
With 83% of enterprise workloads moving to the cloud by 2020, I believe we are about to see Microsoft welcome out ahead. The reason is simple when you break down the business itself. It all boils down to catering to businesses. This is where Microsoft is leaps ahead of Amazon. Microsoft has a distinct edge in the enterprise sector that Amazon has no chance of competing with.
The entire industry is moving towards an enterprise-centric model as businesses start to shift their IT towards cloud in various cloud hybrids.
Both public and private cloud adoption grew in 2018, with larger enterprises increasing their focus on public cloud. AWS is no longer the runaway leader as Azure has grown rapidly and is now a close second, especially among enterprise users.
The numbers are telling the story that enterprise is where the growth is. Considering that Microsoft already has an existing 120 million 365 enterprise users and a billion overall users, I believe that Amazon is going to be the company to cede ground in this battle. And, it is starting to show in the earnings reports.
Microsoft’s earnings surprises
Microsoft has released earnings surprises the past few quarters. The root of these surprises is derived from the earnings from Microsoft’s cloud. From the NASDAQ website, you can see the listing of the earnings surprises over the past few quarters:
Quarterly Earnings Surprise History
Since cloud computing is generally a new business and the growth rate is much greater than a normal business model, the increases have been quite large; earnings increase surprises have mostly been double digits. Since the business is so new, the potential rate of growth is difficult to determine by analysts. This is creating volatility in the markets.
The stock market moved in every instance on the release of these earnings. Respectively, from Sept. 2017-June 2018, the stock moves were 6.41%, -6.71%, 6.65%, and 1.81%. I am thinking that the same will likely happen on Wednesday. However, I am not certain that the stock price will necessarily be positive – more on that below. But, I am betting that the stock will move, along with other stocks within the sector.
Microsoft will likely surprise once again with their earnings release as they have the past several quarters. However, I believe the far more important indicator in this week’s earnings release will be the report on how fast Microsoft’s Azure has increased. This piece of data has the ability to create a great deal of volatility in the markets.
First, if Microsoft Azure has a large increase in their rate of growth, larger than last quarter’s, the perception may be that the company is gaining significant ground on Amazon 33% market share of infrastructure (Azure grew at 89% compared to Q1 FY 2017). I see this as a potential likelihood.
Since Microsoft already has a substantial enterprise customer base, then getting these businesses to start to move their business off of their own servers and into the cloud would be an easy justification. Plus, despite Amazon already having significant market share and growing this at a decent pace, the real future business of the cloud is going to be with enterprise. I see the consumer end being limited in the long run. Microsoft has a tremendous potential in leveraging its already existing 120 million 365 enterprise users and a billion overall users. Amazon is not structured to take advantage of that.
Given that, any perception that Microsoft is gaining ground and doing so at a faster pace would send Microsoft’s stock up higher and subsequently send Amazon’s stock lower. As mentioned, there is a significant amount of business available in the future, some $227.9 billion in 2021 (aggregate of IaaS, SaaS and PaaS). For now, the margins on this business are rich. That is a major amount of revenue and profit potential for any company. And, as these businesses get ramped up more and more, the results are going to hit the bottom line nicely.
I see the two behemoths intertwined at this point with regards to the rate of growth of their respective business, the potential future revenue and ultimately, the stock prices. If one gains significant ground that would be to the detriment of the other’s potential future earnings.
On the other hand, what if there is a pullback in growth? If Microsoft fails to perform, be it for whatever reason, all bets are off and the stock – as well as Amazon’s stock. Both may sell off precipitously. If both companies have significant rates of growth for their cloud business priced into their stock, then any missteps in the earnings and growth rate would mean a necessary revaluation is in order.
Because of these reasons, Wednesday and Thursday are going to be very interesting trading days.
I am already taking a position on Amazon going into their Thursday after-hours earnings release. I am doing so because of the potential market move that will occur. However, I am structuring this trade in Amazon on Wednesday, prior to Microsoft’s earnings release. If the numbers for Microsoft are substantial, either up or down, then the possibility of this moving Amazon’s stock is significant.
At the same time, I am putting on a delta-neutral trade on Microsoft (As I am on Amazon). I am going to go long at-the-money puts while simultaneously going long the stock. The ratio will be 2:1, puts versus stock. This is the simplest way to get into a stock movement that could potentially be volatile. I expect the at-the-money options to be trading approximately $1.85 on Wednesday. With a delta-neutral trade, I would need the market to move approximately 3.5% in two days’ time to be profitable. If you look at the above information, only one of that past four quarters did not move 6%.
I feel comfortable with the potential stock market reaction to the earnings news. Although I am leaning towards a greater-than-expected earnings release and subsequent buying of Microsoft’s stock, I guarantee there are no guarantees; there is potential for the stock to move downward despite better than expected earnings. This happened once before.
Since the market has been so volatile of late, any meaningful news could push the market significantly up or down. As mentioned, I am leaning towards the market heading higher because of the latest selling that the overall market has seen. Any good news out of Microsoft could be the catalyst for buying in the stock market on a whole.
However, the downside to this is that there is no concerted buying or selling. Because of the type of structure I have on for this trade, I just need the stock to move in either direction, up or down. However, if the market does not move, the premium I paid for the option would evaporate and I would be out that money.
Considering the amount of intensity this earnings release is going to have built into it, I am thinking that the market will move. But, no trade is a perfect trade. However, I feel comfortable saying that this trade is a high probability trade. I just need the stock to move. Big.
Disclosure:I/we have no positions in any stocks mentioned, but may initiate a long position in MSFT over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.