"Microsoft: The Third Pillar" (The Emerging Opportunity For MSFT From Generative AI)

Microsoft MSFT Office revenues reached ~$49 billion in FY2023 (up ~70% from FY2018); Office 365 Commercial now has ~400 million paid seats, up >100% from yearend FY2018. Ongoing strength in paid seats (volumes), at +11% YoY in Q4 FY2023, was led by SMB’s and frontline workers. In addition, Microsoft is seeing continued success with it’s higher value offerings (and with the effective implementation of the March 2022 price increases); Office 365 revenues have outgrown paid seats in every quarter for the past 5+ years. (On the Q4 FY2022 call, management said E5 accounted for ~12% of the Office 365 Commercial installed base, up from ~8% a year earlier; on the Q4 FY2023 call, CFO Amy Hood cited “healthy renewal strength”, particularly for ongoing E5 upsell.)

The playbook has worked wonderfully: put simply, leverage the success of the core suite to drive incremental value-add through new tools and services (Teams / telephony, Viva, analytics, etc.). That brings us to the recent generative AI product announcements, with the FT reporting Microsoft will charge commercial customers $30 per user per month for Microsoft 365 Copilot (to put that in context, the list price for E5 is $38 per month). I found this quote from the article noteworthy: “Evidence that the GitHub service has made coders more productive is ‘what’s giving us real confidence that a more horizontal co-pilot like [Microsoft 365]’ will have a big impact on ‘every [type of] sales, finance, HR, or general knowledge work’, Nadella said.” The GitHub service Nadella referred to in that interview is GitHub Copilot, which is now being used in more than 27,000 organizations (up ~2x sequentially).

The rapid adoption of GitHub Copilot reflects the significant impact that it’s having on developer productivity - which makes it well worth the money, even at a price point of ~$20 per month (Nadella: “it's sort of a no-brainer to add productivity leverage for software developers in any organization”). The Sales Copilot demo from Inspire 2023 is another example of how that idea will apply elsewhere inside a company, along with a clear indication why it can be a very attractive value proposition, even at $20 - $30 per seat. In addition, the Copilot demo highlights why Microsoft is well positioned to be the vendor of choice for many customers (“integrates seamlessly with M365 Copilot”).

In summary, the recent results for Office 365 Commercial, along with the significant opportunities for value creation that lie ahead, both exemplify my confidence in Microsoft’s future. While there’s no question a favorable long-term outcome requires effective execution and a best-in-class management team that can keep skating to where the puck is going (for example, the June 2018 acquisition of GitHub), Microsoft possesses sustainable competitive advantages that, in my view, are strengthening further. With the products and services it brings to market, the company makes a strong case for committing to the Microsoft ecosystem - and as the results over the past 5+ years show, that sales pitch is working. (Q4 FY23 call: “We’re rolling out Microsoft 365 Copilot to 600 paid customers through our early access program; feedback from companies like GM, Goodyear, and Lumen is that it’s a game changer for employee productivity.”)

Read the full post at the TSOH Investment Research Service

https://thescienceofhitting.com/p/microsoft-the-third-pillar